What you need to know about opening a brokerage account

Published Wed, June 17 2020 at 11:06 PM PST
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By Obioha Okereke

Ok, so you’ve done the research and you’re more familiar with investing, understand some of things to look for in companies, and you have gathered some money to get started…but how do you actually invest?

Well, first you’ll need to open a brokerage account.

Determine What Type of Account You Need

Do you want to invest in stocks, mutual funds, or etf’s? Or are you interested in cryptocurrency? Leveraged etf’s? It is important to figure out what it is that you want to invest in because depending on the broker you choose, there may be restrictions. Some platforms have limited investment options and won’t have much research available for investors.

Figure out your investment objectives! Are you long-term, or short term? Do you want to play an active role in managing your portfolio, or would you rather be a bit more passive? If you don’t know the answer this question, please go read Passive vs. Active Investing and the other investment articles on the site!

Now, back to picking the right brokerage account. If you have earned income and you’re looking to start investing for retirement, a Roth IRA may make sense for you. Investments in a Roth IRA will grow tax-free, making it a great option for individuals with a long time horizon and more specifically, young investors. The catch is, you can’t withdraw your money until the age of 59.5 years old. There are a few exceptions to this rule:

  • First-time home purchase

  • “Qualified” education expense

  • Medical expenses

  • You become disabled, or pass away

Learn More: Roth IRA Withdrawal Rules

If you don’t want your money tied up and want the ability to withdraw and deposit funds whenever you want, a traditional brokerage account is probably the best option for you. It doesn’t have the same tax advantages of a Roth IRA, but provides more flexibility.

For reference, if you’ve opened a Robinhood account, that would be an example of a self-directed brokerage account. A self-directed account allows you to buy and sell stocks at your discretion, putting you in full control of your investments.

With a managed account, a broker, or an advisor, will manage your investments, making decisions on your behalf.

Personally, I think that regardless of your age and financial status, it never hurts to meet with, or speak on the phone to an advisor to get some direction and guidance.

Keep in mind, if you’re a minor, you will need to open a custodial account.

To Sum Things Up…

Roth IRA - Offered by most brokerages and investment apps. Great option for investors with a long-term investment horizon, and don’t mind having their money tied up for a long period of time.

Pro: Investments grow tax-free

Con: There are income limits, restrictions on withdrawals, contribution limits

Traditional Brokerage Account - Standard brokerage account that is offered by most banks and numerous investment apps/platforms. Unlike the Roth IRA, a traditional brokerage account will not offer tax benefits and you will be asked (required by law) to pay taxes on capital gains!

Pros: No contribution limits, can withdraw money whenever you want, ability to use margin for investments, will sometimes have more investment options than IRA’s

Cons: You have to pay taxes, can be difficult to invest in risky and speculative investments (this is a good thing for new investors, but, I found I was unable to invest in leveraged etf’s through my bank-held brokerage account)

Brokerage accounts will sometimes allow you to use margin, giving you the chance to invest, and short-sell companies, with money that you do not have. Using leverage allows to multiply your profits (or losses) and can be useful for traders, and more experienced investors.

Learn more about Margin Accounts: What is a Margin Account?

What Fees Will I Need to Pay?

In some cases, nothing. Here is a list of some of the fees you need to consider:

Brokerage Fees - Fees charged by the broker/bank that holds your investment account. Broker fees are often applied as annual, maintenance fees but, can include fees to access research, or additional investment options. You can avoid brokerage fees by picking a broker that does not charge broker fees. In my own case, opting in for electronic delivery of all documents and tax information has prevented me from being charged an annual “maintenance” fee on one of my brokerage accounts.

Commission - This can be applied a couple ways. Most commonly, you’ll see it as a trading fee whereby buying, or selling shares will result in a small trading fee. For instance, when you go buy shares of a company, regardless of the amount, you can be charged a small fee. From what I’ve seen, this fee will rarely exceed $10 but, because trading fees are charged on the front, and back-end, if you buy/sell securities often, it can eat into your profits.

Trading fees on different types of securities can differ. You might see larger trading fees on mutual funds and etf’s than you see on stocks.

In some cases, a broker will charge a flat commission fee as a percentage of your capital gains. In other words, for every penny you make, they take a percentage. This is pretty easy to avoid!

Today, there are countless platforms that do no charge broker, or trading fees. Some of the platforms that do not charge trading fees are Robinhood, TD Ameritrade and E-Trade.

Management Fees - A fee paid by investors to the holder of their portfolio. More common among hedge funds and financial advisors. For instance, if you have $10,000 invested with a financial advisor and they charge a 1% management fee on assets, you will be charged $100 that year.

Expense ratio - When investing in mutual funds, index funds, or etf’s, you may see a number titled, ‘expense ratio’. This fee is an annual fee, charged as a percentage of the money you have invested in a a fund. Vanguard is well-known for having some of the lowest, if not the best, expense ratios in the industry.

Learn More: Understanding Investment Fees: From Brokerage Fees to Sales Loads

Where Should I Go to Open an Account?

The following platforms and apps are great for new, and even advanced investors:

Read More: Best Investment Accounts For Young Investors

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