What Is a Brokerage Account?
A brokerage account is an arrangement in which an investor deposits money with a licensed brokerage firm, who places trades on behalf of the customer. Although the brokerage executes the orders, the assets belong to the investors, who typically must claim as taxable income any capital gains incurred from the account.
Understanding Brokerage Accounts
There are multiple types of brokerage accounts and brokerage firms, giving investors the opportunity to cherry-pick the model that best suits their financial needs. Some full-service brokers provide extensive investment advice and charge exorbitantly high fees for such guidance.
On the other end of the compensation spectrum, most online brokers simply provide a secure interface through which investors can place trade orders and charge relatively low fees for this service. Brokerage accounts may also differ in terms of order execution speed, analytical tools, the scope of tradable assets, and the extent to which investors can trade on margin.
Full-Service Brokerage Accounts
Investors seeking the expertise of a financial advisor should align with full-service brokerage firms like Merrill Lynch, Morgan Stanley, Wells Fargo Advisors, and UBS. Financial advisors are paid to help their clients develop investment plans and execute the transactions accordingly. Financial advisors either work on a nondiscretionary basis, where clients must approve transactions, or they may work on a discretionary basis, which does not require client approval.
Full-service brokerage accounts either charge commissions on trades, or they charge advisory fees. A commission account generates a fee anytime an investment is bought or sold, regardless of whether the recommendation came from the client or the advisor, and regardless of whether the trade is profitable.
By contrast, advisory fee accounts charge flat annual fees, ranging from 0.5% to 1.5% on the total account balance. In exchange for this fee, no commissions are charged when investments are bought or sold. Investors should discuss compensation models with financial advisors at the onset of relationships.
Do-it-yourself traders should be careful about trading low-volume stocks, which may not have enough buyers on the other side of the trade, to unload positions.
Discount Brokerage Account
Investors who favor a do-it-yourself investment approach should strongly consider using discount brokerage firms, which impose significantly lower fees than their full-service brokerage firm counterparts. However, as the name suggests, discount brokerage firms like Charles Schwab, Scottrade, E*Trade, Vanguard, and Fidelity offer fewer services in exchange for the lower fees. But this may perfectly suit investors who mainly wish to execute low-cost investment trades via easy-to-use online trading software.
For example, an investor who signs up with a typical discount broker can expect to open a regular taxable brokerage account or retirement account at no cost, as long as he or she is able to fund the account with a $500 opening minimum. To buy or sell most stocks, options or ETFs, there is little or no commission. Some discount brokers may charge fees for non-US stocks, or thingly traded stocks, but this varies from one broker to the next. Treasury bonds typically require no commission to trade, but secondary bonds may vary. Many brokers such as Schwab, Fidelity, and E-trade offer a wide variety of mutual funds available for no transaction cost as well.
- Investors have different needs and should choose their brokerage firms accordingly.
- Investors who require a great deal of guidance and hand-holding may benefit from aligning with a full-service brokerage firm, which charges higher fees.
- Full-service firms either charge flat fees for their service, based on the size of the account, or they charge commissions on the trades they execute.
- Online brokerages charge lower fees and suit investors who wish to conduct their own trades.
Brokerage Account with a Regional Financial Advisor
Some investors prefer the personal interaction of a full-service broker, but also want the benefit of a more personalized approach while working with a firm that feels more localized to the investor's own community. Such investors typically consider using a medium ground between full-service brokerage firms and discount brokerage firms, companies such as Raymond James Financial Advisors, Jeffries Financial Group, or Edward Jones act both as broker-dealers and Financial Advisors. This group requires a larger minimum account size and caters to slightly higher-net-worth individuals, but over time, their services tend to be less expensive than larger, full-size brokerages.
Online Brokerage Accounts and Downward Price Pressure
Launched in early 2015 under a mobile-only platform, online brokerage Robinhood offers commission-free trading and has no minimum account requirements, with the exception of its margin accounts. Although it bypasses commissions, the firm was a pioneer in being able to generate revenue from a practice known as payment for order flow.
Market-making firms that focus on matching buyers and sellers through Electronic Communication Networks (ECNs) need a steady flow of orders from retail investors to match up with institutional buyers and sellers. Firms such as Citadel Securities or IMC Financial, therefore find it useful to create an incentive for brokers to bring them orders. Paying brokers like Robinhood for the right to execute customer trades improved their speed and accuracy of execution and made Robinhood's business model possible.
The amount paid by the market-making firm is far less than what typical equity trade commissions used to be (on a per-trade basis), so even if this cost gets ultimately passed on to the consumer in embedded fees, this model still benefits the consumer because of its reduced cost and efficiency. In late 2019, almost all of the discount brokerage firms fully adopted this business model and switched to free commissions on most equity trades.
In November 2017, Robinhood announced that it had surpassed three million brokerage accounts, exceeding $100 billion in transaction volume. Meanwhile, E*Trade reported approximately 3.6 million brokerage accounts, with $311 billion in assets under management (AUM).
There are drawbacks to zero-fee trading. Case in point: Robinhood does not offer investment advice that's typically available from traditional brokerages. Robinhood likewise does not presently support annuities or retirement accounts. Firm officials say that they may support the latter, in the near future. But even so, Robinhood's model proved to be so successful that late in 2019 the major discount brokers switched to a zero-commission model for most stock trades, demonstrating that customers prefer their approach.