More and more savers are turning to brokerage accounts as they look for ways to maximize their emergency funds in an environment where traditional savings accounts are offering interest rates of just 0.09% on average.
Over 40% of U.S. investors said they had a brokerage account in 2018, compared to 31% in 2012, according to a May 2019 report from investment data research firm Hearts & Wallets.
Brokerage accounts, otherwise known as taxable investment accounts, are similar to a retirement account like a 401(k) or IRA: Investors open one with a broker or investment advisory firm, and can purchase stocks, mutual funds and other assets.
But where retirement accounts have limitations on the amount of money that can be contributed each year and restrictions on when funds can be withdrawn, brokerage accounts are more flexible. There are no income or contribution limits, and investors can withdraw their money at any time, which is part of the reason they are growing in popularity, per the report.
However, they do not offer the same tax benefits as retirement accounts. Traditional IRAs and 401(k)s allow investors to defer taxes until they retire, while Roth IRAs and 401(k)s enable investments to grow tax-free until the contributions are withdrawn (investors contribute money that's already been taxed).
Investors pay taxes when they make money on funds in a brokerage account, such as when they sell a stock or other asset or when a stock pays dividends. However, there are benefits, including a more diverse array of investment options and the potential for growth in the market.
The flexibility, combined with potential investment gains, is attracting more investors to these accounts, Laura Varas, founder and chief executive of Hearts & Wallets, told NerdWallet. "More and more consumers are recognizing the tension between the ability to defer taxes through accounts like 401(k)s and the need for ready access," she said.
Brokerage accounts are ideal for savings or goals that are further than five years away, but closer than retirement, experts say. They can also complement an investor's emergency savings, according to Hearts & Wallets' report.
"There are some circumstances clients should open a brokerage account, such as clients having shorter term goals [like] a cash alternative for a down payment on a house," Ryan J. Marshall, a New Jersey-based certified financial planner, tells CNBC Make It. "In cases where they have goals between four to seven years, a brokerage account may help reach some of those shorter term goals."
But before opening a taxable account, investors should put away a sizable emergency fund and max out their retirement accounts, Marshall says.
"Step one would be to get at least the 401(k) match," Marshall says. "Step two would be to take advantage of a Roth IRA contribution if eligible. Step three would be maxing out the company retirement plan, and then step four would be starting a brokerage account for additional investments."
Before opening a brokerage account, you'll need to do some research to figure out which one is right for you. First, look into your options at financial companies like Vanguard, Fidelity, Schwab and others. You can also look into online brokers like Robinhood.
Next, read up on each trading platform's offerings. Typically, brokerage accounts let investors buy a broader variety of assets than a 401(k), but you should always double check.
Once you've opened an account, which is free to do, you will transfer funds into it in order to buy investments.
The most important thing to watch out for: Fees. There are a variety of fees associated with a brokerage account, just like any investment account, which will largely depend on the broker that manages the account. Major fees to consider include the account maintenance fee, which is a monthly, quarterly or annual fee charged by some brokers, and commissions, which are the fees paid to the broker to execute a trade.
Here's a closer look at the steps it takes to take to open an account:
- Compare brokers: Look at fees and account minimums for online brokers and traditional financial institutions like Vanguard. Different institutions will work better for different types of investors. If you're just starting out, you'll likely want to look for one with low minimums and access to tailored advice, experts say. These are often called "discount brokers."
- Transfer funds: Move money into the account so that you can buy investments.
- Buy investments: Are you interested in stocks? Bonds? Mutual funds or ETFs? Do some research to decide what you actually want to invest in, and why. Many brokers provide their own research that they will give you access to, but you can also read up on stocks and other assets on sites like Morningstar. The amount of money you have to invest will play a big role here: Mutual funds are a great way to diversify your portfolio, for example, but often have higher minimum investments than ETFs. Share prices for a company's stock vary by company. Here are five criteria to consider when picking stocks, here's how to pick the best mutual fund and here are six more things to consider when investing.
From there, if you want to grow your investments, set up an automated transfer to your brokerage account, which you will be able to do online. Just make sure your emergency fund and retirement accounts are adequately funded first.
While savers are using brokerage accounts to supplement savings, they are not the same thing. As with all investing, there is always the risk that you will lose money, though historically the market has always gone up.
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