Before You Open a Brokerage Account

Determining What's Right for You

Before You Open a Brokerage Account, Here Are Some Things To Consider
There are a handful of things you really want to consider before you open a brokerage account. Let me walk you through a few of them. dishapaun / Getty Images

If you want to invest beyond your basic 401(k) or Roth IRA, you are going to need to open something known as a brokerage account.  I've already explained what a brokerage account is an how it works.  Now, I want to talk to you about five things you may want to consider before you open a brokerage account so you are ultimately happy with the decision you make about not only the type of account you open but the firm with which you establish a relationship.

1. Do You Want to Open a Brokerage Account with a Full Service Broker or a Discount Broker?

There are two different types of stock brokers.  The first is known as a traditional broker, or full-service broker.  The second is known as a discount broker.

When you open an account with a traditional broker, you get to work with someone who will become your sounding board; who answers your phone calls and places trades for you.  This person may recommend investments or help you do things such as setup UTMAs for your children to gift them shares of stock.  For this service, you will be charged commissions that are typically several times the cost of a do-it-yourself trade at a discount broker.  The full-service broker and the firm that employs him or her most likely generates considerable profits from this sort of trading activity.  While it may not matter so much if you are affluent or high net worth - after all, not many people see a big difference between an $8.95 commission and a $250.00 commission if you're talking about buying a block of blue chip stock valued at $500,000 and you don't plan on selling it for generations, taking advantage of the stepped-up basis loophole, which explains, in part, the reason full-service brokers appeal to a certain percentage of the rich - it can cut into returns if you have a smaller account.

Some traditional brokerage firms work on hybrid compensation models that blend fixed fees, annual fees as a percentage of assets, and trading commissions.  Additional services are often included in these costs and will vary from broker to broker.  For example, your full-service broker might offer you a list of potential investments based upon your preferred investing strategy (e.g., if you like stable companies that have increased their dividends every year for 25 years, they can have a report prepared for you that lists the ticker symbols, names, and dividend yield of each publicly traded company in the United States that fits your criteria).

 He or she might prepare reports about your portfolio, give you a run-down of how well your investments are doing and, perhaps, even get you access to certain institutional-grade mutual funds, index funds, or exchange traded funds that you otherwise would not be able to buy.

To learn more about this topic, read Is a Full-Service Broker Right for You?, which breaks out additional information that can be useful in determining whether the added expense has benefit for your unique situation.

A discount broker, in contrast, provides tools for you to trade yourself.  You handle the buy and sell orders.  You have no one standing between you and your money if you want to do something dumb, including selling out during a panic or buying on margin during a boom.  For professional or experienced investors who manage their own money, this can be ideal because you don't pay for services you don't want or need.  For example, an E-Trade brokerage account is a discount brokerage account.

Some brokerage firms offer both traditional and discount brokerage accounts to investors, allowing them to select which works better for their situation.

2. What Is the Minimum Opening Balance Required for a Brokerage Account at the Brokerage House You Are Considering?

Different brokerage accounts have different opening balance requirements.

 Some brokerage firms will set a minimum at $1,000, $2,000, or more.  Others may allow you to open an account with a smaller amount of money as long as you agree to regularly have money deposited, often on a monthly basis, from a linked checking or savings account.

If you fail to maintain the minimum opening balance or some other minimum balance requirements, what are the fees?

3. What Services, Perks, Research, and Investment Tools Are Available Once You've Opened Your Brokerage Account?

With full-service brokers, this is somewhat less important to discuss because you presumably have access to the broker himself or herself, who can work with you to uncover a wide range of investment research and reports.  For discount brokers, on the other hand, the difference in offerings can be significant.

 Some firms will give clients free access to equity and mutual fund research data from Morningstar, Thomson Reuters, Standard and Poor's, Credit Suisse, and other institutions and investment banks.  (Unfortunately, I know of no brokerage account that will give you access to one of the best investment research products in the world, the Value Line Investment Survey, which you will have to pay for out of pocket.  It's worth the cost.)

Many brokerage houses have deals with the major credit card companies these days so that clients with a brokerage account can take advantage of certain offerings not available to the general public.  American Express and Charles Schwab recently worked out a high-profile arrangement where the former issued two proprietarily-branded cards in the name of the latter, allowing the card holder to receive benefits based upon their total Schwab brokerage account size plus deposits of cash rewards into the linked brokerage account based upon the volume charged to the card.  One card gives 1.5% in cash back instantly on all eligible purchases, the other allows you to convert American Express rewards points into cash deposits at Schwab.

Certain brokerage accounts at certain brokerage houses will be able to invest commission free into certain select securities including mutual funds, exchange traded funds, and index funds.  For small investors working on a shoestring budget, this can be a great way to save money.

4. What Is the Website and Phone Service of Your Brokerage Firm Like?

Before you open an account, you should fire up your favorite Internet browser and visit the web page of each of the brokerage firms you are considering. If you plan on doing a lot of your research or trading online, the feel of the site is going to be almost as important as the other benefits and services offered.  Some brokerage houses have been notorious for site outages during periods of high market volatility or trading.  Others send brokerage account owners through a maze of recorded messages before reaching a person.  

5. How Informative Are the Account Statements on the Brokerage Account?

Over the years, my family and I have had a lot of different brokerage accounts at a lot of different institutions.  One of the thing that amazes me is the quality difference in the statements produced by some firms versus others.  For the past eight years, the primary custodian we've used is, hands down, the best.  Whenever we open another account, I contact them and have them switch to a specific layout that isn't the ordinary default.  This modified layout allows me to see things such as the total number of days, on a per-lot basis, each position has been open, estimate the annual income from dividends and interest, and break out securities by asset class.

You might also want to look at the brokerage account trade confirmations, too.  I once had an account with an affiliate of a well-respected bank.  The trade confirmations would routinely show up with significant, material errors on them that would require immediate correction.  

6. Do You Want to Open a Margin Brokerage Account or a Cash Brokerage Account?

I've talked to you about buying stock on margin.  I've explained how, for most investors under most circumstances, it is demonstrably dumb.  It exposes you to risks to which you shouldn't be exposed and invites what amounts to a partner into your financial decision-making in that the lender (your broker) can decide it wants to sell your positions even if they are undervalued, locking in your losses.  If you aren't careful, you can .  Still, if you are going to trade on margin, you may want to see how the brokerage account structures its margin terms (e.g., some stock traders want a more advanced form of margin calculation known as "portfolio margin" in their brokerage account), and the rates at which margin loans are extended.

Personally, given my concern that rehypothecation could become a disaster under the wrong circumstances, I'd suggest you open a cash account, instead.  Yes, it is a little less convenient but it offers you certain protections that I think are well worth the (minor) trouble.  To learn more about this topic, read Cash Account vs Margin Account.

7. How Financially Strong Is the Brokerage Firm at Which You Are Opening a Brokerage Account and Is It Covered By SIPC Insurance and Any Extra Insurance?

Financial institutions, including brokerage firms, fail.  One way to lessen the risk of being caught in the mess is to only open brokerage accounts at strong institutions.  Brokers will make their financial statements available to you to examine, and many are publicly traded, anyway, so you can also find out about their parent company through the Form 10-K and annual report, among other sources.  

Beyond this, you want to inquire about the broker's SIPC coverage.  In certain circumstances, you may want to check the coverage and rules, carefully, and only invest the assets in your brokerage account in a way that gives you maximum protection at all times, including adhering to certain account limits or trading of specific types of securities.

Some investors, particularly wealthier investors, opt to use a custody account at a different institution than the brokerage firm handling the execution of their trades.  Alternatively, you can decide you want to go to the expense and hassle of having your equities registered through the DRS.