What Is a Brokerage Account and How Do I Open One?

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So you’ve got your emergency fund taken care of — great! Now what?

While you need cash you can easily access in the event of an emergency, once you’ve stashed about six months of living expenses in your savings account, it’s time to start thinking more in terms of a long-term financial strategy. That means shifting up from simply saving to investing. And the easiest way to do that is with a brokerage account. 

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What Is a Brokerage Account?

A brokerage account is like a savings account that exists solely for the purpose of investing — in just about any investment there is. A brokerage account can be used to purchase stocks, bonds, mutual funds, exchange-traded funds, index funds, options, futures, foreign currencies, real estate investment trusts, and just about anything else you can possibly invest in. 

Like a savings account, a brokerage account is very liquid, meaning you can take out money anytime (though this might involve selling investments or incurring capital gains taxes). You can also set up automatic transfers, and in some cases even link it up to a checking account.

There’s one pretty big difference between the two, though: While your savings account is FDIC insured up to $250,000, money in a brokerage account is not. And if your investments tank (see: Crisis, Financial), you can lose a lot of hard-earned money very quickly.

That said, interest rates are currently at all-time lows, meaning that stuffing more money into your savings account is just barely better than sticking it under a mattress — you’re actually losing money when you take inflation into account. Investing through a brokerage account, meanwhile, allows your money to grow at a rate greater than inflation over the long term, especially if you leave it alone for long periods of time and avoid as many fees as possible.

How Do I Open a Brokerage Account?

Whoa, slow down a minute. First, don’t even think about opening a brokerage account until you have at least three months of living expenses socked away for a rainy day. That means enough money to pay your mortgage or rent, all your bills, and still put food on the table for three months. Six months is better. And some experts have even said that, with lingering uncertainty in the job market, a year’s worth of expenses might be more prudent.

You should also be maximizing any tax-advantaged accounts you have access to, like a 401(k) or IRA, because brokerage accounts are not generally tax-free (although you can open an IRA or Roth IRA at some brokerage firms and purchase stocks within them). If your employer offers a company match on your 401(k) contributions, make sure you’re contributing enough to get that free money before you start funneling funds into a brokerage account.

Once you’ve met those two basic prerequisites, you’re going to be spoiled for choice when it comes to selecting a brokerage account. There are tons of options out there, even for people who never want to set foot inside a brokerage house. Like other financial services, most brokerages let you set up everything online these days, and you can simply link up your existing checking or savings account to fund a new brokerage account.

So, what should you be looking for in a brokerage account?

Find a brokerage account with low or no fees.

This is particularly important for those with a small nest egg who are just starting out. The fees on each transaction in a brokerage account can be significant, devouring your gains if you have a low balance.

For example, Scottrade charges $7 for most trades, which is fairly low by industry standards. But if you’re only trading $100 at a time, that fee will eat up 7% of your investment, plus another 7% when you sell it later.) Anything over 1%, and you should keep looking. 

Once your account is set up, remember that slow and steady wins the race.

When you log into your online dashboard, it’s tempting to fiddle with your account. Maybe you want to buy whatever hot stock you heard about on CNBC, or the company that makes your new favorite product.

But virtually every study shows that the best investment strategy is to consistently invest your money, leave it alone, and let the miracle of compound interest do the work for you. Brokerage accounts let you invest in just about anything anytime — but they also allow you to set your preferred allocations, and then leave your money alone. That’s your best bet.

Explore alternatives if you’re only interested in mutual funds or index funds. While you can buy mutual funds, index funds, and ETFs through a brokerage account, sometimes you can purchase these investments directly from the institution that offers them (such as Vanguard or Fidelity), without any middle man fees, and get access to the same kinds of services that brokerage account holders have. 

Start Comparing Brokerage Accounts

It’ll take a bit of legwork and research on your part, but finding the right brokerage firm and setting up an investment account isn’t rocket science. It’s mostly about comparing costs, available investment options, and account features, and seeing which firm fits your temperament and needs best.

The good news is, we’ve done some of the hard work for you: Check out our favorite online stock brokers here to get started.

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