What is a brokerage account?
A brokerage account is an investment account held at a licensed brokerage firm that lets an investor buy and sell securities—stocks, bonds, mutual funds, exchange-traded funds (ETFs), and other instruments. You fund the account with cash, and the broker carries out your orders. The securities are owned by the investor; any gains, losses, dividends, or interest in the account are reported by the investor for tax purposes.
Key definitions
– Cash account: A basic brokerage account in which you may buy securities only with the cash you have deposited. No margin borrowing, short selling, or many options trades are allowed from a pure cash account.
– Margin account: An account that permits you to borrow from the broker using the securities in the account as collateral. Borrowing increases buying power but also creates interest charges and the possibility of margin calls.
– Margin call: A broker’s demand for additional funds or securities when the equity in a margin account falls below the broker’s required maintenance level.
– Full-service broker: A firm (or advisor) that provides investment advice, financial planning, and other wealth-management services; typically charges higher fees or requires larger minimum balances.
– Discount broker: A broker that offers execution and basic services at lower cost; many modern discount brokers charge no commissions for standard equity and ETF trades.
– Robo-advisor: A digital platform that manages portfolios using algorithms and model allocations, usually for a low flat fee or a small percentage of assets under management.
– Discretionary vs nondiscretionary account: In a discretionary arrangement an advisor can trade without client approval; in a nondiscretionary relationship the client must approve trades.
Types of brokerage accounts (overview)
– Standard taxable brokerage account: For regular investing; gains and income are taxed in the year they are realized.
– Retirement brokerage accounts (IRAs): Tax-advantaged accounts—e.g., traditional IRA and Roth IRA—with distinct tax rules and contribution limits.
– Cash accounts: Restrict trades to funds on hand.
– Margin accounts: Allow borrowing; introduce interest costs and liquidation risk.
– Full-service vs discount vs regional vs robo-advisor: Differ by service level, cost, minimum balance, and human advice availability.
How brokerage firms differ
Look for differences in:
– Fees (commissions, spreads, advisory fees, account maintenance).
– Tradable asset selection (stocks, bonds, options, futures, crypto).
– Tools and research (charting, screeners, model portfolios).
– Execution speed and order routing.
– Account minimums and funding options.
– Customer service and advisory availability.
– Margin terms (interest rate and maintenance requirements).
Are brokerage accounts safe?
– Broker insolvency vs market risk: Securities held in your brokerage are generally owned by you, but they can be affected by market losses. If a brokerage fails, protections such as SIPC (Securities Investor Protection Corporation) may help recover missing customer securities and cash up to limits; SIPC does not protect against investment losses caused by market movements.
– Verify your broker’s registration with regulators (SEC/FINRA) and check SIPC membership when relevant. Be aware of how uninvested cash is held (sweep to banks may be FDIC-insured up to limits).
How to choose a brokerage account — quick checklist
Before opening an account, confirm:
– Account type availability (taxable, IRA, custodial, retirement).
– Fees and fee structure (commissions, advisory fees, fund expense ratios).
– Margin policies and interest rates.
– Range of tradable assets (stocks, ETFs, mutual funds, bonds, crypto).
– Platform reliability, mobile app, and research tools.
– Minimum deposit required.
– Regulatory registration (SEC/FINRA) and SIPC membership.
– Customer support and dispute resolution mechanisms.
– Tax reporting features (1099s, cost-basis tracking).
How to open a brokerage account — typical steps
1. Choose the brokerage and account type (taxable, traditional IRA, Roth IRA, etc.).
2. Provide personal information (ID, Social Security number or taxpayer ID, contact and employment details).
3. Agree to account agreements (margin agreement if you want margin trading, options agreement if you want options).
4. Fund the account by transfer (ACH, wire) or by transferring an existing brokerage account.
5. Set up security features (two-factor authentication) and review platform settings.
6. Start placing trades or set up a managed solution (advisor or robo-advisor).
Practical numeric example — margin borrowing and a margin call
Assumptions:
– Initial cash deposited: $10,000
– Broker allows 50% initial margin (you can borrow up to your deposit), so you buy $20,
000 of stock: $10,000 cash + $10,000 borrowed.
Assumptions (continued)
– Maintenance margin requirement (the minimum equity ratio you must maintain): 25% (0.25).
– No dividends, no additional purchases, no interest accrual for the short time frame in this example.
Definitions (brief)
– Market value (V): current total value of your securities.
– Loan (L): amount borrowed from the broker.
– Equity (E): V − L.
– Equity ratio (or margin level): E / V.
Step-by-step: when does a margin call occur?
1. Start: V0 = $20,000, L = $10,000, E0 = V0 − L = $10,000. Equity ratio = 10,000 / 20,000 = 50%.
2. A margin call occurs when E / V < maintenance margin (m). Solve for the critical market value V_crit where equality holds:
– (V_crit − L) / V_crit = m
– 1 − (L / V_crit) = m
– V_crit = L / (1 − m)
With L = $10,000 and m = 0.25:
– V_crit = 10,000 / (1 − 0.25) = 10,000 / 0.75 = $13,333.33.
So if the portfolio falls below $13,333.33 in market value, the equity ratio drops below 25% and the broker can issue a margin call.
Worked numeric scenarios
A. Price falls to the margin-call trigger
– New market value V = $13,333.33.
– Equity E = V − L = 13,333.33 − 10,000 = $3,333.33.
– Equity ratio = 3,333.33 / 13,333.33 = 25% (exactly the maintenance level).
B. Price falls further to $12,000 (example of an actual margin call)
– V = $12,000.
– E = 12,000 − 10,000 = $2,000.
– Equity ratio = 2,000 / 12,000 = 16.67% 0 you must act).
– If you need to liquidate to meet the call, compute the sale amount S using S = V − (E / m).
– Contact your broker immediately and document any trades or transfers you execute.
– If you plan to add cash or eligible marginable securities instead of selling, confirm acceptance with your broker before making transfers.
Worked numeric example (step-by-step)
Assumptions
– Account market value of securities, V = $10,000.
– Account equity (securities − loan), E = $2,000.
– Broker maintenance margin, m = 25% (0.25).
Goal: find S, the dollar value of securities to sell so that post-sale equity meets maintenance margin.
1) Use the derived formula S = V − (E / m).
2) Compute E / m = 2,000 / 0.25 = 8,000.
3) Compute S = 10,000 − 8,000 = 2,000.
Interpretation: Sell $2,000 of securities and apply proceeds to reduce the margin loan; after the sale the new market value = V − S = $8,000 and equity = E (unchanged before applying proceeds) + S applied to loan → effectively equity meets m × new market value = 0.25 × $8,000 = $2,000.
Checks and caveats
– This algebra assumes proceeds from the sale are applied immediately to reduce loan principal and that equity E is measured before the sale.
– It ignores commissions, bid/ask effects, settlement timing, interest on the loan, taxes, and dividend/corporate-action adjustments.
– If S computes as zero or negative, no sale is required to meet the maintenance margin (no shortfall).
– Brokers may allow or require alternative cures (adding cash or marginable securities); confirm permitted assets and timelines with your broker.
– Rapid price moves can change V and E between calculation and execution; leave a margin of safety where practical.
Common pitfalls
– Using the wrong equity figure: equity = market value of securities − margin loan balance.
– Forgetting that some securities are not marginable or are marginally marginable at lower rates.
– Ignoring transaction costs and settlement lag that can affect effective equity.
– Assuming Regulation T (initial margin) and broker maintenance margins are the same — they are different rules.
Selected references
– FINRA — Margin: Understanding Margin Accounts: https://www.finra.org/investors/learn-to-invest/types-investments/margin
– Federal Reserve — Regulation T (initial margin requirements): https://www.federalreserve.gov/supervisionreg/reg-t.htm
– U.S. Securities and Exchange Commission — Investor Bulletin: Margin Accounts: https://www.sec.gov/oiea/investor-alerts-and-bulletins/ib_marginaccounts
– Investopedia — Brokerage Account (margin overview): https://www.investopedia.com/terms/b/brokerageaccount.asp