What is a brokerage account?

"What is a brokerage account?" you ask...  it sounds like you're new to dividend investing.

Well, you're in the right place.

Here we run through the mechanics of buying and holding stocks as well as other types of investment. You'll find all the basics about a brokerage account, the thing you will need above all else to be a dividende stock investor.

Read our Q&A below to get you started with your investment story! 

Dividend investing 101 - What is a brokerage account?
1. What does a brokerage account do?

Put briefly, a brokerage account is an account held with a licensed firm that allows you to deposit money and buy and hold stocks. These days nearly all brokerage accounts are set up and operated online although you may need to send in documents to begin with in order to prove to the company that you are who you say you are. 

Once the account is open you deposit cash with the broker and use it to purchase a range of financial securities. These could include stocks, bonds, ETFs, Real Estate Investment Trusts (REITS), Mutual Funds and some other financial instruments.

All brokers are different but many brokers these days can collect dividends for you, show and analyse your portfolio, keep tax and cost records, and some will reinvest dividends for you automatically if you choose. 

Dividend investing 101 - What is a brokerage account?
2. What can you buy with a brokerage account?

Before you open the brokerage account, you should have a think about your investment goals and what you'll be investing in. The most common financial securities for you to invest in include:

Common stocks (aka "shares")- ownership stakes in businesses. These can range from a small start up to enormous multi-national companies. 

Bonds - shares of the debt of a company, government (state and national), or mortgage/asset backed securities. US government bonds are known as "treasuries". These offer promises of repayment on a certain date and regular interest payments and are considered to be very secure, particularly if backed by a government or very large company.

ETFs (exchange traded funds) - collections of stocks and other investments which give you the option to invest in many indexes from around the world or particular sectors or geographies. ETFs (unlike mutual funds - see below) tend to trade in a similar way to stocks. Click here for more information on ETFs.

REITs (Real Estate Investment Trusts) - companies set up to invest in property. This could be commercial property such as office buildings, warehouses, shopping malls, or hotels. REITs can also invest in residential property. REITs often receive favorable tax treatment as long as they pay out a certain proportion of their earnings as dividends. 

Mutual Funds - These are companies which pool together many investors' cash to invest in certain securities. The idea is that the investor can use the expertise of a fund manager and will benefit from diversification. You may not actually need a brokerage account to invest in a mutual fund as often this can be done directly with the mutual fund manager. Well known mutual fund providers include Fidelity, Franklin Templeton, and Blackrock. 

Preferred stocks - bond like investments that rank senior to stocks but below regular bonds in the hierarchy of "what gets paid if the company goes bust". They usually provide greater returns than bonds but do not have the same potential upside as stocks.

Options - financial instruments which allow you to exercise the right to buy or sell a security at a certain point in the future. These are divided into "calls" (the option to buy in the future) and "puts" (the option to sell in the future). 

Dividend investing 101 - What is a brokerage account?
3. What is "buying on margin"? (and why to avoid it!)

Many brokers give you the option of buying securities on margin. This means the broker will offer to lend you money to buy securities. You will usually pay a small amount (maybe 10-20%) as a deposit and your purchase is "secured" on the asset you buy.

We advise you to completely avoid purchasing securities on margin or, at least, to be extremely cautious when doing so. The reason why is that if the value of the asset you invest in falls then you'll be required to "post more collateral" which usually means injecting more cash into your account. If you don't, then you could be forced to sell. Remember that markets can do simply anything in the short term and be very volatile.

Trading on margin puts you at the mercy of the markets and is highly speculative. Read more about the difference between speculating and investing here.

Dividend investing 101 - What is a brokerage account?
4. What should you look for in a brokerage account?

We think that these are the main things to take into account when looking for a brokerage account:

  • a good track record of financial stability
  • good customer services
  • low and suitable dealing fees
  • a good range of securities and geographies that you can invest in
  • other useful services, and possibly tools that you can use for stock research. For more on these then have a read of our page on finding the best online brokerage.

Dividend investing 101 - What is a brokerage account?
5. Do you need a full service or discount broker?

You'll need to decide if you want a full service broker or a discount broker. A full service brokerage account will be more expensive but will give you a personal service. Generally you will have a personalised advisor assigned who will get to know you and your family's financial situation, discuss your financial goals and objectives, suggest possible products and investments for you, etc.

A discount broker will do none of the above and all the decisions will be up to you. That said, it will be far cheaper for you and you'll typically only pay the dealing charges which are often in the $5-10 range. 

Make sure that you are aware of how frequently you are likely to deal when opening an account. If you are unlikely to trade frequently then you'll need to make sure there are no inactivity fees on the account you're opening. Also, many brokerage accounts demand a minimum initial deposit size which is usually in the range of $500-$2500. 

Dividend investing 101 - What is a brokerage account?
6. Can you switch brokers?

What if you become disappointed in your broker or they introduce new charges that don't fit with your requirements. Can you switch accounts in these circumstances?

Luckily this has become easier over recent years.

You will have to contact your broker and let them know that you wish to transfer your assets out. You'll then need to find a new brokerage account, open the account, and fill in a "transfer in" form. After this, there is usually little to do although the whole process can often take a month or so. The good news is you won't need to sell assets and buy them back but many brokers will charge you a fee for transferring your holdings. Make sure you check out their policies for transferring in/out. 

Dividend investing 101 - What is a brokerage account?
7. What if your broker goes bust?

This is a nightmare scenario for any investor that we all hope to avoid. Unfortunately it can (and does from time to time) happen. We think you should be careful about who you open accounts with and stick to those names with a solid reputation and a good financial history (many brokers are supported by banks or are separately listed). It may mean that you don't open accounts with the cheapest brokers but it isn't worth the stress of having a broker possibly going bust on you. 

Brokers are meant to segregate your assets from their own. This means that your securities and cash are held in separate accounts to their own which should make it easier to identify your assets if the broker were to go under. That said, there have been cases where brokers (such as MF Global) mixed client assets and their own assets. 

You should aim to protect yourself as much as possible from the chances of your broker going bust. We'd recommend avoiding brokers who heavily advertise lending on margin. This is because if their borrowers default on them, bankruptcy is more likely. 

Dividend investing 101 - What is a brokerage account?
8. Are you protected by a regulator?

In developed markets, yes, but the effectiveness and swiftness of the response by the regulator to broker bankruptcies is largely untested. 

In the US, investors are typically protected under FINRA where brokers sign up to the Securities Investor Protection Corporation (SIPC). This should protect your account up to a value of $500,000 per customer and includes $250,000 of cash. You can find more information here. In the UK, investors are protected under the FCA. For details of regulators in other countries, click here.

Dividend investing 101 - What is a brokerage account?
9. Who are the main brokers?

You have many choices of possible brokers and a lot depends on whether you want a full service or discount broker. Some of the most common discount brokers in the US include: Ally Financial, Scottrade, Charles Schwab, TD Ameritrade, E-Trade, and Fidelity.

Hopefully now you've got a clear answer to the question: "What is a brokerage account?" Click here for our recommendations for the best brokers to go for, depending on YOUR circumstances.

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Mike - six-figure dividend earner

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