What Is a Brokerage Account?
Brokerage accounts allow you to invest your funds and, if needed, liquidate assets and make withdrawals at any time. We break down how they work and where they may fit into your financial plan.
Sean Canonica
Senior Finance Writer
Sean is a finance writer and content strategist for ComparisonAdviser. He has over three years of experience writing about various topics, such as insurance, financial advisors, and investing. Additionally, he is a co-founder and the CEO of RateSonic, an online insurance resource. Sean values helping readers understand difficult topics by creating easy-to-read and thorough content.
View ProfileInvesting is an important way to both build and preserve one’s wealth. Many types of accounts, including a Roth IRA and 401(k), allow you to house your investments and, in most cases, buy and sell securities. A brokerage account is another option that lets you hold your assets and make trades to further your financial goals.
In this article, we’ll outline how a brokerage account works and what role it may play in your investment strategy. Additionally, you’ll learn about its pros and cons, as well as how to establish an account for yourself.
Key Takeaways
- A brokerage account is a taxable investment account that allows you to house and trade securities.
- Unlike a Roth IRA or 401(k), brokerage accounts give investors complete freedom to contribute and withdraw as much as they want at any time.
- Whenever you sell a security for a profit, you may need to pay a federal or state capital gains tax.
- Because of their liquidity, brokerage accounts are ideal for short-term goals, such as buying a house.
How Brokerage Accounts Work
A brokerage account is a taxable account that contains assets you’re currently holding, such as stocks, bonds, or shares of mutual funds. They allow you to buy and sell securities when the markets are open via the financial institution that offers the account. Typically, banks and broker-dealers, such as Fidelity and Vanguard, offer these accounts to investors.
Within a brokerage account, as mentioned, you may buy and sell a wide variety of securities. These include:
Brokerage accounts operate very similarly to other types of investment accounts, such as Roth IRAs and 401(k)s. The key difference, however, is that the former doesn’t set rules on how much you may contribute or withdraw and at what time you may do so. This allows you more freedom to manage the account as you see fit.
While you do receive complete freedom over a brokerage account, be aware that it is taxable. When you sell your securities for a profit, you’ll be subject to the capital gains tax at the federal and, if applicable, state level.
Thomas Cook, CFP, EA, financial planner and founder at Retire to Tellico, describes the brokerage account as “one of the most underrated investment accounts” because it “offers the most flexibility regarding when and what money” investors can use. As an example, he explains that securities “held in a brokerage account longer than a year qualify for special tax treatment when sold” and the “gains can fall within the 0% tax bracket if your taxable income is below $94,050 as married filing jointly tax status in 2024.”
Pros and Cons of Brokerage Accounts
Brokerage accounts are highly useful tools for investors. They can provide you the ability to easily invest and withdraw when necessary. The “liquidity and flexibility” benefits make this type of account ideal for “short-term goals, such as saving for a down payment, funding education expenses, or pursuing medium-term financial objectives,” says Taylor Kovar, CFP, founder and CEO at 11 Financial.
While a brokerage account may afford you many benefits, it’s also important to consider the risks associated with it. Per Kovar, “The primary risks include market volatility, potential losses on investments, and fees associated with trading and managing the account.” It’s also important to remember that brokerage accounts are taxable, which eats into your overall profits when you sell a security.
Pros
- Ideal for short-term goals.
- Freedom to contribute and withdraw any amount.
- Wide variety of investment options, including stocks, bonds, mutual funds, and ETFs.
Cons
- Subject to income and capital gains tax.
- Trading fees whenever you buy and sell securities.
- Market volatility may cause you to lose some or all of your principal investment.
Where Brokerage Accounts Fit into Financial Plan
Brokerage accounts are a helpful resource for investors to keep their funds liquid and within reach. However, rather than the minimal gains one might see with a savings account, one can expect the potential of sizable returns over time. These two benefits present a compelling argument for one to include a brokerage account within their financial plan.
Cook, an experienced financial planner, points out that “saving in a brokerage account could make a lot of sense” if you “have goals with time horizons before retirement.” For example, if you’re saving to place a down payment on a home or for a dream vacation, funds in a brokerage account, if properly invested, could grow substantially more than if you simply had them in a savings or money market account. It’s important, however, to consider that you risk losing some or all of your money due to market volatility.
Because of the market volatility risks and taxable nature of a brokerage account, it’s more likely that you’ll want to use it for short-term goals. Long-term goals, such as retirement, require your funds to sit safely in tax-advantaged accounts, such as a 401(k) or IRA, building over time for when you’re ready to use them.
How to Set One Up
Opening a brokerage account is a relatively simple process. The first step is to select a brokerage firm, such as Vanguard, Fidelity, or Charles Schwab. Then, you’ll be able to open an account and begin funding it by depositing money.
Many companies also allow you to utilize a robo-advisor, or automated portfolio manager, along with your brokerage account. This is a form of artificial intelligence that invests in securities on your behalf based on your goals, risk tolerance, and time horizon. Alternatively, with enough of an initial investment, you may hire a discretionary investment manager to assist you.
Due to the risk associated with trading within a brokerage account, we recommend you consult with a financial advisor before you begin. To find a high-quality professional near you, consider using a free matching tool. This will match you with a vetted advisor near you based on your goals and current financial situation.
Frequently Asked Questions
How are brokerage accounts taxed?
You must pay taxes on earnings you make within your brokerage account. Any time you sell a security for a profit, you will owe a capital gains tax. The rate you must pay depends on how long you hold the asset and your federal income tax bracket.
Are brokerage accounts FDIC-insured?
No, the FDIC does not insure brokerage accounts. However, SIPC insurance will shield your assets from any risk associated with financial troubles at the brokerage firm itself. Losses you incur from trading activity aren’t protected by insurance.
Is a Roth IRA a brokerage account?
While Roth IRAs have many similarities to a brokerage account, they aren’t quite the same. The former is a tax-advantaged investment account that imposes restrictions on what you may contribute and when you may distribute funds without penalty. With the latter, you have complete control over deposits and withdrawals, but the profits you make are taxed.
Is there a penalty for withdrawing from a brokerage account?
You may withdraw funds from your brokerage account at any time. Be aware, however, that if you liquidate a security to do so, you must pay taxes on any earnings you make.