Pros and Cons of Brokerage Accounts

What Is a Brokerage Account?

A brokerage account is an account you can use to invest in securities such as stocks, mutual funds, exchange-traded funds (ETFs), bonds and more. You can use a brokerage account to build wealth and save for financial goals, such as retirement, home remodeling, a child's wedding or other major expenses.

After opening and funding a brokerage account with an investment brokerage, you can either make your own investment decisions, buying and selling stocks yourself; use a robo-advisor to choose investments for you; or have a human financial advisor manage your investments.

Assuming you're already fully funding an employer-sponsored retirement account such as a 401(k) or individual retirement account (IRA), have an emergency fund and don't have excessive credit card debt, a brokerage account can be a useful addition to your financial portfolio. But there are advantages and disadvantages to be aware of before you open a brokerage account.

Pros of Brokerage Accounts

Brokerage accounts offer several advantages that can help you make the most of your money.

Allow Easy Diversification

Brokerage accounts give you the freedom to allocate your investments based on your financial goals and risk tolerance. Diversifying your portfolio by investing in a mix of assets (such as stocks and bonds), as well as buying investments in a range of locations and industries, can help reduce risk and minimize any negative impact of market ups and downs.

Relatively Liquid

Although your money isn't quite as accessible as it would be in a checking account, a brokerage account lets you withdraw cash whenever you like without paying a penalty (though if you're cashing out investments, it'll trigger capital gains taxes). In contrast, withdrawing money from tax-advantaged investment accounts such as 401(k)s, 403(b)s or IRAs before age 59½ can trigger income taxes plus a 10% penalty on the amount you withdraw.

Easy to Open

You can generally open a brokerage account online or in person in a matter of minutes by providing your personal information, annual income, tax status and tolerance for risk. You may even be able to open a brokerage account with no money.

No Required Minimum Distributions

Tax-advantaged retirement accounts usually require you to start taking required minimum distributions (RMDs) at age 72 and pay income taxes on them (unless you're withdrawing money from a Roth IRA). If you don't take your RMD, the amount you should have withdrawn will be taxed at 50%. Brokerage accounts don't require RMDs.

No Contribution Limits

Retirement accounts cap the amount you can contribute each year, which can limit your investments' potential for growth. For 2023, you can contribute a maximum of $22,500 to a 401(k) or 403(b) plan and $6,500 to a Roth or traditional IRA. People 50 and up can make additional catch-up contributions of $7,500 for a 401(k) and $1,000 for an IRA. You can put as much as you want into a brokerage account.

Accounts Are Typically Insured

Brokerage firms that are members of the Securities Investor Protection Corporation (SIPC), which includes most brokerages registered with the Securities and Exchange Commission (SEC) insure your account for up to $500,000 should your brokerage go out of business. Half of that, or $250,000, can be used to cover cash. Keep in mind, however, your money is not insured against investment losses.

Cons of Brokerage Accounts

Brokerage accounts have some downsides to consider.

May Charge Fees

You are likely to encounter a variety of fees when you open a brokerage account and purchase investments. These can include annual fees, account maintenance fees, management or advisory fees, and fees for purchasing or selling investments.

They're Taxable

Some tax-advantaged retirement accounts don't tax your deposits; instead, you'll pay taxes when you take distributions in retirement. Brokerage accounts tax you on earnings when they are realized, which usually happens when an investment is sold or a dividend paid.

They Involve Risk

When you put money into a traditional or high-yield savings account insured by the Federal Deposit Insurance Corp. (FDIC) or National Credit Union Association (NCUA), your money is guaranteed up to $250,000 per person, per financial institution. The SIPC insures member brokerage accounts if your brokerage fails, but it doesn't protect against losses if your investments decline in value. Purchasing investments inherently involves risk. You'll need to strike the right balance between safer investments that typically deliver lower returns and riskier investments that have the potential for a bigger payoff (and bigger losses) to ensure your investments are diversified.

May Have Minimum Deposit and Balance Requirements

Although some brokerages let you open accounts for free, others require an initial minimum deposit, which could be thousands of dollars. You might also have to maintain a certain balance in your account to avoid maintenance fees.

The Bottom Line

You can build a foundation of financial security by contributing to your workplace or individual retirement account, paying down debt and building a solid emergency fund. If your budget allows, opening a brokerage account can be a convenient way to expand your options. Weigh the pros and cons of opening a brokerage account before making your decision.

Purchasing investments doesn't affect your credit scores unless you open a margin account. With this kind of brokerage account, you can borrow money from the brokerage to purchase stock. The brokerage may check your credit when you apply for a margin account, which could cause a small, temporary drop in your credit score. If the value of your investments drops too far, you might struggle to repay the money you owe the brokerage. Should your account be sent to collections, it could damage your credit score. You can avoid this risk by opening a cash account, which doesn't involve borrowing money.