investing
Investing can be fun, but you need a brokerage account to do it. Fortunately, it’s easy to get started.A low-cost brokerage account will allow you to buy individual stocks, mutual funds, exchange-traded funds and other investments outside of your employer’s retirement account. You can open an account, deposit money and execute trades online with a computer, a tablet or even a smartphone.
But first, you have to pick a brokerage firm. The one that’s right for you depends on the kinds of services you want. For starters, check out Kiplinger’s annual survey of online brokerage firms, which rates nine online brokers on a variety of measures, from fees to breadth of investment offerings to customer service.
What You Need to Open an AccountBrokerage firms make it easy to open an account online, as long as you meet a few requirements. You must have a valid Social Security number and a legal U.S. residential address within the 50 states, the District of Columbia or Puerto Rico, among other things.
You’ll have to choose whether you want to open a taxable (non-retirement) account or a retirement account (such as a traditional or Roth IRA). Both types of accounts allow you to buy and sell stocks, mutual funds, ETFs and other investments.
One thing you won’t need is a ton of money. Many online brokerage firms, including Schwab and Fidelity, don’t require a minimum to open an account, though some firms may require a modest balance of, say, $500 or $1,000. And at most brokerages, trading is free.
You can contribute as much or as little as you want to a taxable brokerage account in any given year. But retirement accounts come with annual contribution limits. For example, you can invest up to $6,000 in an IRA each year if you’re younger than 50 years old or $7,000 if you’re 50 or older.
TaxesThere are tax consequences to consider if you trade securities in a taxable brokerage account. Any profits you pocket when you sell an investment will incur capital gains taxes. How much you owe depends on how long you’ve owned the investment. (Trades in a traditional or Roth IRA brokerage account don’t create a taxable event as long as the money stays in the account.)
Suppose you buy 10 shares of Apple stock in your brokerage account for $165 per share, and the price appreciates to $300. Your shares are worth $3,000, for a gain of $1,350. If you sell all of your shares and you’ve owned them for less than one year, you’ll pay the short-term capital gains rate—your ordinary income tax rate—on those profits. But if you’ve held the shares for a year or longer, you’ll pay a lower tax—the long-term capital gains rate—of 0%, 15% or 20%, depending on your marginal income tax bracket.
What if the stock drops in value and you sell? You can use those losses to offset any capital gains realized on other investments, as long as you match up short-term losses with short-term gains and long-term losses with long-term gains. If you end up with a surfeit of losses, you can deduct up to $3,000 in losses from your income and carry over unused losses on future tax returns.
Hiring a (Robo) ProIf you’re nervous about trading stocks or funds on your own, or if you just don’t want to bother, consider the low-fee advisory services driven by computer algorithms that many brokerage firms offer. You fill out a short online questionnaire about how long you plan to invest (a “time horizon”) and your tolerance for risk, and a computer model recommends a portfolio of low-cost ETFs that are right for you.
These robo-advisers, as they’re commonly called, charge low annual fees and do all the investment work for you, from rebalancing your portfolio to shifting your assets to an appropriate mix over time as you age. Brokerage firm Betterment, for example, offers a robo service for an advisory fee of 0.25% to 0.40% per year, depending on the account balance, and its portfolios charge a typical annual expense ratio of 0.11%. For our take on 12 robos, see Find the Right Robo Adviser for You.
How Your Account is ProtectedAssuming your brokerage firm is a member of the Securities Investor Protection Corp. (and most are), your account is insured in the event your brokerage goes out of business.
Brokerages are required by law to keep customers’ investments separate from securities owned by the brokerage firm, an arrangement that offers some protection against fraud. But if the firm fails and customers’ assets go missing due to theft, fraud or unauthorized trading, SIPC will protect each account held by a customer for up to $500,000 for securities and cash (including a $250,000 limit for cash only). SIPC won’t protect you against investment losses, and it doesn’t get involved until the firm has exhausted all other options, such as merging with another brokerage firm.
The Risks of Trading on MarginIf you followed the meteoric rise of GameStop stock and other so-called meme stocks last year, you probably heard a little about margin trading. When you trade on margin, you borrow money from your brokerage firm—using your cash and securities as collateral—to buy securities. These accounts allow you to increase your buying power (regulators allow you to borrow up to 50% of the purchase price), but typically you have to apply and qualify for one at your brokerage firm.
Margin trading is mostly for sophisticated investors or speculators because it’s risky—you can lose more than you invested. And margin accounts charge high interest rates (Fidelity charges 8.325% on loans of up to $24,999). Margin rates are variable, too, and they’ll head higher when the Federal Reserve hikes short-term interest rates. There’s a minimum amount of collateral to maintain as well. Just how much can vary: The Financial Industry Regulatory Authority, the self-regulatory arm of the brokerage industry, requires that you keep a minimum of at least 25% of the value of the margin securities, but some firms call for more.
If the market heads down, you may have to add cash or securities to restore the minimum maintenance amount—the dreaded margin call. If you don’t, your broker has the right to sell your investments to cover it. That could amplify your losses, because your investments will likely be sold at a loss. Plus, you’re still on the hook to pay the margin loan back to the broker.