Types of Brokerage Accounts

Looking at the amount of interest you make each month on your savings or checking account at your bank might make you a little disgruntled. That’s why many people decide to enter the wide world of investing. Investors put their money into the stock market in hopes that they can make enough to at least cover the rising costs of inflation, and hopefully more. Investing in the stock market— whether you choose individual stocks, index funds, mutual funds, exchange-traded funds (ETFs) or bonds—can be a way to put your hard-earned money to work.

Whether you want to start investing for the first time, or just want to learn more about brokerage accounts, it’s important to understand the basics before you enter the ring.

What Is a Brokerage Account?

To put it simply, a brokerage account gives you access to the securities market and allows you to buy and sell individual stocks, ETFs, bonds, as well as mutual funds—also referred to as market securities.

When you’re ready, you can link your bank account to your brokerage account in order to transfer money. Once your money has successfully transferred, you can start trading different securities.

There are several different types of brokerage accounts; therefore, you will want to understand which type is right for you.

What is a retirement brokerage account?

You may notice that brokerage accounts are often called taxable accounts, especially by brokers; this is because investment income within a brokerage account is taxed. This means that when tax season rolls around, you will have to go into your brokerage account to calculate how much money you made off your investments during the calendar year.

In contrast, retirement brokerage accounts like 401(k)s, Roths and IRAs are considered separate because they have a different set of tax rules. While you’ll have to pay taxes on investments in brokerage accounts, you may actually get a tax deduction for depositing money into your retirement brokerage account each year—but will have to pay taxes if you withdraw money. Retirement brokerage accounts are not tax-free, but they are considered tax-deferred.

Can I transfer stock from a brokerage account to a Roth IRA or traditional IRA?

If you’re wondering if you can transfer stock from a brokerage account to a Roth IRA, you cannot. This is because a brokerage account and a retirement account are two separate arenas. You can make regular contributions to your Roth IRA by cash or check, which is especially important around tax season, but you cannot contribute securities from your standard brokerage account. Think of these two entities as separate accounts to be managed in different ways.

Likewise, if you want to convert a brokerage account to a Roth IRA, it’s not as easy as you think it would be. Converting a brokerage account to a Roth IRA or traditional IRA means you will have to sell off your securities in your taxable brokerage account and move the cash into the IRA. Your broker or brokerage firm should be able to assist on how to effectively convert a brokerage account to a Roth IRA or traditional IRA.

Is a brokerage and trading account the same?

Although brokerages and trading accounts are very similar and can hold the same securities, they often are not used synonymously by brokers.

A trading account is typically distinguished from other investment accounts by the level of activity, purpose of that activity and the risk it involves—such as day trading. Because day traders tend to buy and sell assets frequently, often within one trading session, their accounts may be subject to specific regulation from the Financial Industry Regulatory Authority (FINRA).

Lastly, unlike a brokerage account, a trading account may only require minimal personal information, which makes it easier to open.

Can I have multiple brokerage accounts?

Yes, you can have multiple brokerage accounts. However, it’s important to understand why you’d want multiple accounts and how to go about opening them. Choosing to have one instead multiple brokerage accounts makes it easier to analyze your overall portfolio, assess its risk level and make necessary adjustments to stay in line with what you’re comfortable doing with your investments. Overall, having one brokerage account is simple and will not get lost in the shuffle.

However, for some investors who want to diversify their portfolios, having multiple brokerage accounts could help you take full advantage of the strengths of different brokers. A few reasons that having multiple brokerage accounts could be beneficial are:

• More data and research: While some brokerage firms offer exclusive in-house data, educational resources and commentary, others may not offer these services and you may be forced to find this information elsewhere.
• No fees or discounts: You’ll want to be aware of trade commissions and annual expense ratios, as well as transaction, advisory, management or retirement account fees.
• Decreased margin costs: As the interest fees increase or decrease through Federal Reserve rate changes, margin costs could potentially fluctuate causing these costs to go from minimal to extravagant.

If you have specific needs for achieving your investment goals, you’ll want to make sure your brokerage account fits the above criteria. Having multiple brokerage accounts could help if you want to rely on one for data and research and another for its minimal fees and associated costs.

Lastly, if you are deciding between having one or multiple brokerage accounts, you can always rely on other resources for investment education and data like the American Association of Individual Investors (AAII), which specializes in providing non-biased information.

Types of Brokerage Accounts: Margin Account Versus Cash Account

When you start researching types of brokerage accounts, it can be quite overwhelming with how many options there are for investors these days. It’s important to consider your overall investment objectives before you decide. Additionally, before you choose which type of brokerage account is right for you, you’ll want to consider the two main categories, a cash or margin account, as well as who will be managing your portfolio. Depending on your current funds and investment goals, choosing between a margin account and a cash account will be a vital first decision.

Cash brokerage accounts

A cash account is a type of brokerage account in which the investor must pay the full amount for securities at the time of purchase. For example, if you intend to buy 50 shares of a stock, you must have the appropriate funds transferred into the account before the purchase occurs. A cash brokerage account is similar to having a debit card, where you can only spend the money that you currently have.

In a cash account, you are not allowed to borrow money from your broker to pay for your transactions. For beginner investors or people who want to limit their risk, your potential losses within a cash brokerage account are capped at the amount you invest. In some regard, a cash account gives you more control over your investments and offers lower risk for people who want to focus on long-term investing. Ultimately, it is your decision if a cash brokerage account is right for you.

Margin brokerage account

In comparison, a margin brokerage account is when your firm can lend you money to buy securities such as stocks, funds, bonds, etc. It’s important to think of margin accounts as a loan, or credit card, where you will rack up interest costs that you will have to pay back accordingly. To put it simply, your brokerage firm loans you the funds to purchase your securities.

You may be wondering why investors would choose a loan versus paying outright for their securities. A margin brokerage account gives investors more options such as flexibility, an increase in buying power and potential, as well as the ability to leverage your investments and increase the returns when the prices of your holdings are moving in your favor.

However, be aware of the unfavorable aspects of a margin brokerage account, such as the amount of risk you are forced to take on. If the securities you’re using as collateral go down in price, your firm can issue a margin call, which is a demand that you repay all or part of the loan. Another disadvantage of choosing a margin account is that you can lose more money than you originally invested because you are trading on a loan. Also, you must repay both the amount you borrowed and interest, even if you lose money on your investment.

Learning the pros and cons of a margin account versus a cash account, plus your own risk tolerance and cash flow, will determine the type of brokerage account you’ll want to pursue.

What is a portfolio margin account?

Let’s start with the basics: Margin is the collateral that an investor puts up in order to get a loan from your broker, firm or exchange to allow you to trade. Like any loan, your brokerage firm wants to know that you will be able to cover what you’ve borrowed in the future. The term portfolio margin refers to margin requirements that pertain to the risk of all securities in a portfolio, not just an individual security. This risk is calculated by fully understanding the impact of overall market volatility when a loan is initiated. A portfolio margin account can give the investor even more buying power than a traditional margin account.

With a portfolio margin account, you must meet certain requirements in order to be qualified. To open a portfolio margin account, you must have an initial net liquidating value of at least $125,000 and it must be a non-retirement brokerage account.

Can you switch from margin to cash accounts easily?

Yes, you can switch from margin to cash accounts by either selling all of your current loaned investments and withdrawing the entire account balance or using your margin loan to get cash from your account, backed by your current investments.

Some modern online brokerage firms like Robinhood make it fairly convenient to switch from margin accounts to cash accounts, more so than mature firms like E-Trade or Vanguard. As long as you settle all outstanding debts on your side, you should be able to switch from a margin account to a cash account without hassle. You can also consult a broker if you are having difficulties with this transition.

Managing Your Assets Within a Brokerage Account

Whether you’re ready to start investing, want to switch from a margin account to a cash account, or find out if you can have multiple brokerage accounts, you will want to make sure you have the tools and resources to make the right decisions.

AAII offers countless articles so you can become a well-informed individual investor. Once you’re set up with the right brokerage account that fits your individual needs, you can start making smart investing decisions with AAII’s stock grades and screeners. With AAII’s A+ Investor subscription and the right brokerage account, you can invest confidently in your future. You can monitor your investments, discover new opportunities and learn which strategies work—all inside our A+ Investor service.