There’s just one more thing you need to do before you can buy your first stock. And that is to open a stockbroker account. Think of it this way. Just like you need a bank account to do your banking, you need a bokerage account to do your stock investing. You’ve probably had, and used, a bank account for years.
So you’re already familiar with banking accounts (checking, savings, etc.). You keep your cash in your bank accounts. And you make deposits, and withdrawals, write checks, and make transfers of that cash into and out of those accounts.
Similarly, you keep your stocks in your bokerage account (and bonds, mutual funds, etc. – we’ll focus on stocks to keep it simple).
And you buy and sell stocks in that account. Interestingly, you also keep some cash for investments in that account, so that you can buy stocks. And when you sell a stock, the cash from that sale is put back into your broker account. And once you have opened a stockbroker account, you can start investing in stocks.
That is to say, you can start buying and selling stocks using that account. To open a stockbroker account, you will need to choose a stockbroker. This is similar to when you opened your banking account.
You had to choose a bank to open it with. So you may have looked at Bank of America, USBank, a regional or local bank, etc., and chosen one of them. Similarly, you will need to choose a stockbroker to open an account with. I’ll list a number of them for you, and even tell you which one I have used, quite satisfactorily, for years.
How To Choose A Broker
When you choose a stockbroker (or broker) you will have to decide if you want a full-service broker or an online discount broker. With a full-service broker, you pay the broker a commission to do your buying and selling for you.
Typically, they may make stock recommendations as well. Your advantage with a full-service broker is that you won’t have to learn how to place buy and sell orders, and you will have the assurance a professional is doing this for you.
And you will have access to their advice and recommendations. Of course, they will charge you commissions for this service. Or you can open an online discount broker account and do all of your trading (buying and selling stocks) yourself.
While that option is not free, as the name implies, the commissions for trading your online account run at a big discount to having a broker do the trades for you.
Before you choose a broker, you also need to analyze your personal investing style, and then you can proceed to find the kind of broker that fits your needs. It’s almost like choosing shoes; if you don’t know your size, you can’t get a proper fit (and you can be in for a really uncomfortable future).
When it’s time to choose a broker, keep the following points in mind:
- Match your investment style with a brokerage firm that charges the least amount of money for the services you’re likely to use most frequently.
- Compare all the costs of buying, selling, and holding stocks and other securities through a broker. Don’t compare only commissions; compare other costs, too, like margin interest and other service charges.
- Use broker comparison services available in financial publications such as Kiplinger’s Personal Finance and Barron’s (and, of course, their websites) as well as online sources.
Learn more about the roles of stockbrokers.
List Of Online Brokers
There are many good online discount brokers you can use. Here are some thoughts about them for you. There are online discount brokers and super discount brokers.
I tend to avoid the super discount guys. I had trouble with a super discount broker in my commodity options trading past, so I favor the more run-of-the-mill, average discount brokers. Some brokers that fit this description are:
- TDAmeritrade – www.tdameritrade.com
- Scottrade – www.scottrade.com
- E*Trade – www.etrade.com
- Fidelity Investments – www.fidelity.com
- Charles Schwab – www.schwab.com
Setting up and keeping an account with these brokers should be free, and the cost per trade (when you buy or sell a stock) should be around $10. Some will be more, some less. For example, I recently saw a television commercial for Scottrade advertising $7 per trade.
Since you probably won’t be trading that frequently, a few dollars more or less is probably not a big deal. So I tend to choose these things based more on ease of use. Another consideration is how many trades you may do per year.
Your number of trades may range from none to no more than five or ten in some months (and that’s kind of high, actually). Note that I said typically here. I may have made forty trades in one month during the peak of the market problems in 2008-2009 – but that is not typical.
Another consideration is whether you work in an office during the day and want to occasionally check on your stocks. In this case, you may be accessing your online stockbroker account through your employer’s computer.
You will want to make sure the broker you chose can be accessed through your company’s computer firewall. I can tell you from personal experience that TDAmeritrade works fine through the firewalls of companies I’ve worked for in the past, and I have read that Scottrade is set up this way as well.
The others listed above may very well work too, but you will want to verify this upfront with them when you are setting up your stock account.
Types of Brokerage Accounts
When you start investing in the stock market, you have to somehow actually pay for the stocks you buy. Most brokerage firms offer investors several types of accounts, each serving a different purpose. I present three of the most common types in the following sections.
The basic difference boils down to how particular brokers view your creditworthiness when it comes to buying and selling securities.
If your credit isn’t great, your only choice is a cash account. If your credit is good, you can open either a cash account or a margin account. After you qualify for a margin account, you can (with additional approval) upgrade it to do options trades.
A cash account (also referred to as a Type 1 account) means just what you’d think. You must deposit a sum of money along with the new account application to begin trading. The amount of your initial deposit varies from broker to broker.
Some brokers have a minimum of $10,000; others let you open an account for as little as $500. Once in a while, you may see a broker offering cash accounts with no minimum deposit, usually as part of a promotion. Use the resources in Appendix A to help you shop around. Qualifying for a cash account is usually easy, as long as you have cash and a pulse.
With a cash account, your money has to be deposited in the account before the closing (or settlement) date for any trade you make. The closing occurs three business days after the date you make the trade (the date of execution). You may be required to have the money in the account even before the date of execution.
In other words, if you call your broker on Monday, October 10, and order 50 shares of CashLess Corp. at $20 per share, then on Thursday, October 13, you better have $1,000 in cash sitting in your account (plus commission). Otherwise, the purchase doesn’t go through.
In addition, ask the broker how long it takes deposited cash (such as a check) to be available for investing. Some brokers put a hold on checks for up to ten business days (or longer), regardless of how soon that check clears your account (that would drive me crazy!).
See whether your broker will pay you interest on the uninvested cash in your brokerage account. Some brokers offer a service in which uninvested money earns money market rates, and you can even choose between a regular money market account and a tax-free municipal money market account.
A margin account (also called a Type 2 account) allows you to borrow money against the securities in the account to buy more stock. Because you can borrow in a margin account, you have to be qualified and approved by the broker. After you’re approved, this newfound credit gives you more leverage so you can buy more stock or do short selling.
For stock trading, the margin limit is 50 percent. For example, if you plan to buy $10,000 worth of stock on margin, you need at least $5,000 in cash (or securities owned) sitting in your account. The interest rate you pay varies depending on the broker, but most brokers generally charge a rate that’s several points higher than their own borrowing rate.
Why use margin? Margin is to stocks what mortgage is to buying real estate. You can buy real estate with all cash, but using borrowed funds often makes sense because you may not have enough money to make a 100-percent cash purchase, or you may just prefer not to pay all cash. With margin, you can, for example, buy $10,000 worth of stock with as little as $5,000. The balance of the stock purchase is acquired using a loan (margin) from the brokerage firm.
Personally, I’m not a big fan of margin, and I use it sparingly. Margin is a form of leverage that can work out fine if you’re correct but can be very dangerous if the market moves against you. It’s best applied with stocks that are generally stable and dividend-paying. That way, the dividends help pay off the margin interest.
An options account (also referred to as a Type 3 account) gives you all the capabilities of a margin account (which in turn also gives you the capabilities of a cash account) plus the ability to trade options on stocks and stock indexes. To upgrade your margin account to an options account, the broker usually asks you to sign a statement that you’re knowledgeable about options and familiar with the risks associated with them.
Opening An Account
To open an account you will need some basic information such as:
- Your Social Security Number or Individual Taxpayer Identification Number (ITIN)
- Your employer’s name and address
It should take just a few minutes to fill out the application for a simple, individual account. And it is not complicated if you are making an initial cash deposit to set it up.
It gets a bit more involved if you are opening an IRA account, and transferring stocks and funds from 401k’s that you have had with previous employers. If you are doing this, then you will need a copy of you 401k accounts before you start.
But don’t be put off by this additional paperwork. This is actually a good idea to consolidate your old 401k’s into one account that you can manage.
Otherwise, they are just sitting there, going up and down based on the whims of the market. And probably costing you too much in fees, as they are notorious for that. Also, you will have many more investment choices in your new consolidated account.
When I was a broker, I often helped people consolidate all of their old 401k’s, which they couldn’t do anything with, into a new account.
This way they could take control of their future, and trade and direct these funds they had accumulated from past employers. So if you want to start investing in stocks, take the time to open your broker account. And remember, you only have to do this once. Then you are good to go.
Brokerage accounts vs. IRA
Standard brokerage accounts allow you to contribute after-tax money, and your investment earnings are taxed in most cases. Brokerage accounts have very few rules: You can withdraw money at any time, for any reason, and you can invest as much as you wish. (Here are our top picks for the best brokerage accounts.)
A Roth IRA lets you contribute after-tax money, and once you reach 5912, you can take distributions from your account, including earnings, without having to pay additional federal income taxes.
Ideally, you should have both, but the Roth IRA is best because you can grow your money tax-free.
It is ideal to have both, but it depends on your goals. IRAs are a good way to save money for retirement, but they tie up your money for many years.
A brokerage account would be more suitable if you wish to save money for a down payment on a house.
Instead of a taxable brokerage account, you may want to open a retirement account to invest for retirement.
You might already be investing for retirement through your employer – many companies offer employee retirement plans, including 401(k)s. IRAs are fine, but you should at least contribute to your 401(k) to qualify for the match.