You may know that many people have brokerage accounts. You may also have heard family and friends discuss their brokerage accounts and investments. What is a brokerage account?
What is a brokerage account?
A brokerage account is an agreement whereby an investor pays money to a licensed brokerage firm that performs transactions on behalf of the client. Although the brokerage house executes orders, the assets belong to investors who usually must claim as taxable income all capital gains from the account.
Types of investments on the brokerage account
You can buy many types of investments on the brokerage account, including but not limited to:
- Ordinary shares representing ownership interests in enterprises
- Preferred shares, which usually do not reduce the company’s profits, but tend to pay dividends higher than average
- Bonds, including US Treasury Securities, Savings Bonds, Corporate Bonds, Tax Free Municipal Bonds and Agency Bonds
- Real Estate Investment Funds (REITs), which represent pools of real estate assets, including some types of specialization, such as hotel REITs, which focus on owning and operating hotels
- Stock options and other derivatives, which may include call options and put options that give you the right or obligation to buy or sell a given security at a given price before the expiry date
- Money markets and certificates of deposit, which represent either ownership in pools of highly liquid investment funds that hold cash and fixed income investments, or loans to a bank in exchange for a fixed interest rate
- Mutual funds, which are combined investment portfolios owned by many smaller investors who buy shares in the portfolio or trust the owner of the portfolio. Instead of trading all day, as other assets do, buy and sell orders are placed at the end of the day at the same time. Mutual funds include index funds.
- Funds dealt in on the stock exchange (ETF), which are a type of collateral similar to mutual funds, including index funds. ETFs are listed on stock exchanges and can be traded like shares
- Master Limited Partnerships (MLP), which are complex partnerships with tax benefits (and potential tax consequences)
Ways to use a brokerage account
Many investors open a brokerage account to start saving for retirement. However, the flexibility of this type of account means that you can withdraw at any time and use the funds also for short-term purposes, such as a new home, wedding or major remodeling project.
Tax on brokerage account
Brokerage and retirement accounts are taxed differently. Contributions to traditional IRAs and normal amounts of 401 (k) are made before paying income tax on wages, the balance increases over time, and you pay taxes when you withdraw money for retirement. For Roth IRA and Roth 401 (k) s, contributions are paid after paying income taxes, money increases over time, and you don’t pay taxes when you retire.
