How to open a trading account

A low-cost brokerage account will allow you to purchase 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 using a computer, tablet, or even a smartphone.

But first, you need to choose a brokerage firm. The right one for you depends on the types of services you want. To get started, take a look by Kiplinger annual survey of online brokerage firmswhich rates nine online brokers on a variety of measures, from fees to breadth of investment offerings and customer service.

What you need to open an account

Brokerage 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 residential address in the US within the 50 states, the District of Columbia, or Puerto Rico, among other things.

You will 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, do not require a minimum to open an account, although 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 like 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 under 50 or $7,000 if you’re 50 or older.

Taxes

There are tax consequences to consider if you trade securities in a taxable brokerage account. Any profit you make when you sell an investment will incur capital gains tax. The amount you owe depends on how long you have owned the investment. (Transactions in a traditional or Roth IRA brokerage account do not create a taxable event as long as the money remains in the account.)

Suppose you buy 10 shares of Apple in your brokerage account at $165 per share and the price rises to $300. His shares are worth $3,000, for a profit of $1,350. If you sell all of your shares and have held them for less than a year, you’ll pay the short-term capital gains rate, your ordinary income tax rate, on those gains. But if you’ve owned the stock for a year or more, 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 happens if the stock goes down in value and you sell? You can use those losses to offset any capital gains made on other investments, as long as you combine short-term losses with short-term gains and long-term losses with long-term gains. If you end up with excess losses, you can deduct up to $3,000 in losses from your income and carry unused losses forward on future tax returns.

Hire a (Robo) Pro

If you’re nervous about trading stocks or funds on your own, or just don’t want to bother, consider the low-cost, computer algorithm-driven advisory services offered by many brokerage firms. Complete a short online questionnaire about how long you plan to invest (a “time horizon”) and your risk tolerance, and a computer model recommends a portfolio of low-cost ETFs that are right for you.

Are robotic advisors, as they are commonly called, charge low annual fees and do all the investment work for you, from rebalancing your portfolio to shifting your assets into a suitable 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 account balance, and its portfolios charge a typical annual expense ratio of 0.11%. For our 12-steal version, see Find the right Robo Advisor for you.

How your account is protected

Assuming your brokerage firm is a member of the Securities Investor Protection Corporation. (and most are), your account is insured in case your brokerage goes out of business.

Brokerage firms are required by law to keep clients’ investments separate from securities owned by the brokerage firm, an arrangement that offers some protection against fraud. But if the business goes bankrupt and customer assets go missing due to theft, fraud or unauthorized transactions, SIPC will protect each customer account for up to $500,000 for securities and cash (including a $250,000 limit for cash only). SIPC will not protect you against investment losses, and does not become involved until the firm has exhausted all other options, such as merging with another brokerage firm.

The risks of trading on margin

If you followed the meteoric rise of GameStop stock and other so-called meme stocks last year, you’ve probably heard a bit 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 you usually have to apply and qualify for one at your brokerage firm.

Margin trading is primarily for sophisticated investors or speculators because it is risky – you can lose more than you invested. And margin accounts charge high interest rates (Fidelity charges 8.325% on loans up to $24,999). Margin rates are also variable and will go up when the The Federal Reserve raises short-term interest rates. There is a minimum amount of collateral to maintain as well. How much can vary: The Financial Industry Regulatory Authority, the self-regulatory arm of the brokerage industry, requires that you hold a minimum of at least 25% of the value of margin securities, but some companies require more.

If the market heads down, you may need 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 you. That could amplify your losses, because your investments will likely be sold at a loss. In addition, you are still obligated to pay the margin loan to the broker.

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