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Brokerage Accounts

Brokerage Accounts

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Author: Sophia Tutorial
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Explain the purpose of brokerage accounts and the role of brokerage firms.

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Tutorial

what's covered
In this lesson, you will learn about brokerage accounts and the different types of brokerage firms. You will explore how your productivity skill can be a real benefit in this process. Specifically, this lesson will cover:
  1. Overview of Brokerage Accounts
    1. Choosing a Brokerage Account
    2. Self-Directed Compared to Full-Service Accounts
    3. Opening a Self-Directed Account
  2. Placing Orders
    1. Types of Orders
    2. Online Orders
  3. Reading a Brokerage Statement

1. Overview of Brokerage Accounts

1a. Choosing a Brokerage Account
A brokerage account is a prefunded arrangement between you and a broker-dealer firm that allows you to buy and sell investment assets. The following flow chart shows the primary choices that you need to make in the account selection process.

concept to know

The process of opening a brokerage account is relatively easy and similar to establishing an online bank account, with a few additional considerations.
a flow chart with four outcomes: (stage one) do you want to work with a stockbroker or go it alone? (stage two) choose a full-service brokerage or a self-directed brokerage; (stage three) do you want to borrow money or use your own? (stage four) in either brokerage model, use your own money only in a cash account or use your own money and borrowed money in a margin account

First, you need to decide if you want to work with a broker or manage the assets in the account on your own.

  • Full-service brokerage firms, sometimes referred to as broker-dealers, match you with a broker – a financial professional who will provide guidance and support throughout the investing process. Stockbrokers are also known as investment representatives, registered representatives, or account managers. Firms such as UBS, Merrill Lynch Advisors, Raymond James, and Morgan Stanley dominate the full-service marketplace.
  • A self-directed brokerage account allows you to make your own investment decisions. Firms like Charles Schwab, Fidelity, TD Ameritrade, and E*Trade provide this option.
Second, you must also decide if your broker-dealer will allow you to purchase securities with borrowed money.

  • A cash account is the most common and requires you to pay, in advance, for all securities purchased.
  • A margin account allows you to buy stocks, bonds, and other assets with borrowed money. Most often, margin accounts, because they involve borrowing, are reserved for wealthy clients who have both a high credit rating and a high risk tolerance.
terms to know

Brokerage Account
A prefunded arrangement between you and a broker-dealer firm that allows you to buy and sell investment assets.
Stockbroker
Registered representatives, or account managers. Also known as investment representatives.
Cash Account
The most common and requires you to pay, in advance, for all securities purchased.
Margin Account
A type of brokerage account that allows an investor to purchase investments with borrowed money.
1b. Self-Directed Compared to Full-Service Accounts
As a brokerage-firm client, you must pay for the advice and guidance provided.
  • By law, brokers are required to get to know you. This just means that brokers must learn as much about your goals, attitudes, financial situation, and risk tolerance as possible.
  • Brokers are required to use this information to help guide their recommendations.
  • Because of this, the fees and commissions charged in full-service brokerage accounts will be higher than those charged in self-directed accounts.
big idea
If you have a self-directed brokerage account, you are totally responsible for making your own investment decisions. The investment choices you make are yours and yours alone.

The table below compares estimated minimum account values, fees, and commissions charged in self-directed and full-service brokerage accounts. Generally, given the lower fees and commissions, self-directed accounts are the better option for individuals just getting started with investing. If you decide later during your lifetime financial journey that you need help managing your assets, a full-service brokerage account might be appropriate.

Account Information* Self-Directed Account Full-Service Account
Minimum initial deposit $1,000 $25,000
Minimum initial deposit for individual retirement account $500 $5,000
Minimum initial deposit for 529 savings plan $100 $1,000
Minimum initial deposit for educational savings account $250 $1,000
Flat rate online commission per trade $8.95 $25 plus commissions of 1% up to 5% of the sale
Fee for certificates of deposit $0.00 $0.00
Annual account maintenance fee $0.00 unless account value drops below initial minimum investment, then $100 $0.00 unless account value drops below initial minimum investment, then $100
* This is an example. Actual minimum requirements and fee rate schedules vary.

If you plan to go it alone through a self-directed account, you’ll need to bring along your productivity skills . Review the quick tips in the toolbox below. Keeping these tips handy will give you the confidence you need to make the best investment decisions.


of

1c. Opening a Self-Directed Account
You might be thinking, “This all seems too complicated and uncomfortable.” This is a common reaction but one that is easily remedied. Letʼs walk through the process of opening a self-directed account.

step by step
  1. Make sure you have some money saved that can be used for investment purposes.
  2. Conduct an Internet search for “self-directed brokerage account.” Compare the options among several of the companies listed and then select the firm that has a low minimum account balance, low (or no) trading commissions, and low (or no) account fees.
  3. Check that the firm offers Securities Investor Protection Corporation (SIPC) insurance, which protects your account up to $500,000 per customer, per firm, with up to a $250,000 limit for cash. SIPC covers you in the event that the brokerage firm goes out of business or experiences theft. Keep in mind that SIPC does not insure against losses in the markets.
  4. Open the account. You can begin buying and selling securities almost immediately.

hint
You will always want to make sure that you already have some savings set aside for emergencies and other short-term goals.


2. Placing Orders

2a. Types of Orders
When you make your first stock purchase, you will be asked how you want your purchase to be handled. You have three basic choices, as shown in the following illustration.

illustration of a woman trading stocks on a computer with three thought clouds above her head: (cloud one) market order, (cloud two) limit order, (cloud three) stop order

  1. Market order, which instructs the brokerage firm to buy (or sell) at the current ask or bid price. This is the fastest way to transact trades in an account. However, a market order does not guarantee the buy or sell price because sudden market swings can alter the price.
  2. Limit order, which tells the brokerage firm to only buy (or sell) at a specific price or better. Letʼs say you want to buy shares in a company only if the price drops below $25 per share. The limit order will stay in effect until the price drops under $25. It is important to use limit orders when you are buying or selling stock that does not have many buyers and sellers, or if you are trading a stock with large daily price swings (see Hint below).
  3. Stop order (sometimes known as a stop-loss order), which directs the brokerage firm to buy (or sell) only when the price falls below a set point, say, $24.50. If the stock price jumps down from $25 to $22, then the stock will sell at the next available price ($22) even though the order was set at $24.50. In some situations, a stop-loss order will require the stock price to trade at an exact amount for it to be sold.
hint
By using limit orders, you are able to protect yourself against sudden price swings in the market price.

Some investors also use a buy stop or sell stop order. A buy stop sets a limit on how much you are willing to pay, whereas a sell stop instructs the brokerage firm to sell shares if the price falls.

terms to know

Market Order
Instructs a brokerage firm to buy (or sell) at the current market value; the fastest way to transact trades in an account.
Limit Order
Tells the brokerage firm to only buy (or sell) at a specific price or better.
Stop Order
Directs the brokerage firm to buy (or sell) only when the price falls below a set point. Sometimes known as a stop-loss order.
2b. Online Orders
In todayʼs highly technical world, most brokerage account activity is handled online.
  • Years ago, you would have received a stock certificate, which is paper proof of ownership, whenever you purchased shares of stock.
  • Although you can still receive a certificate, nearly all brokerage firms require that you hold shares of stock in street name. This refers to the brokerage firm being shown as the owner of record even though you, as the brokerage account client, actually own the shares.
  • Street-name ownership allows for quicker and simpler transactions.

3. Reading a Brokerage Statement

Once your account is set up, you will begin to receive account statements, like the one shown in the following illustration (see Hint). Looking at TJʼs account in the illustration, you can see that she withdrew $1,000 from the account, earned $50 in interest, and paid a $30 account fee. TJʼs investments also increased by $300 during the month.

hint
Similar to your bank account, it is important to review your brokerage account statement monthly.

a sample brokerage account statement with seven primary sections: (one) the name and address of the brokerage firm; (two) the name of the client; (three) summary of investments held in the account; (four) opening account balance; (five) ending account balance; (six) allocation of investments in the account; (seven) summary of account activity

summary
In this lesson, you went through an overview of brokerage accounts. When you choose a brokerage account, you should compare the features of self-directed and full-service accounts. With a self-directed account, you’ll make your own investment decisions. You will need to use your productivity skill to make sure you are on top of things. If you open a self-directed account, be sure the firm offers SIPC insurance. Conversely, full-service brokerage firms will match you with a broker who can help you interpret and read your brokerage statements.

When you’re ready to place an order for stocks, you’ll select from three types of orders: a market order, a limit order, or a stop order. With the advent of the Internet, most orders today are placed as online orders.

Source: This content has been adapted from Chapter 8.8 of Introduction to Personal Finance: Beginning Your Financial Journey. Copyright © 2019 John Wiley & Sons, Inc. All rights reserved. Used by arrangement with John Wiley & Sons, Inc.

Wiley and the Wiley logo are trademarks or registered trademarks of John Wiley & Sons, Inc. and/or its affiliates in the United States and other countries.

Terms to Know
Brokerage Account

A prefunded arrangement between you and a broker–dealer firm that allows you to buy and sell investment assets.

Cash Account

The most common and requires you to pay, in advance, for all securities purchased.

Limit Order

Tells the brokerage firm to only buy (or sell) at a specific price or better.

Margin Account

A type of brokerage account that allows an investor to purchase investments with borrowed money.

Market Order

Instructs a brokerage firm to buy (or sell) at the current market value; the fastest way to transact trades in an account.

Stockbroker

Registered representatives, or account managers. Also known as investment representatives.

Stop Order

Directs the brokerage firm to buy (or sell) only when the price falls below a set point. Sometimes known as a stop-loss order.