What Type of Brokerage Account Is Right for You?

A broker, also known as a brokerage, is a company that connects buyers and sellers of investment vehicles like stocks and bonds. A brokerage account is often where an investor keeps assets. In general, there are three types to choose from. Which type you choose depends on your needs and preferences.

Quick History of Brokerages

Before the middle of the twentieth century, access to stock and bond markets was restricted to those with enough money to invest and use a human broker's services.

In the 1970s and 1980s, "discount" brokerage firms such as Vanguard and Charles Schwab emerged. They were willing to take on a less affluent clientele because their business models were designed around investor volume.

Online brokerages such as E*TRADE, FOREX.com, and Ameritrade (now TD Ameritrade, under Charles Schwab) flourished as they seized the opportunity created by the internet at the turn of the century. New technology reduced costs and allowed them to extend the discount brokerage model by reducing commissions and minimum balances.

The Rise of Self-Directed Investing

Online brokerage accounts brought about the self-directed investor. These investors conduct investment research and choose which stocks and bonds to buy for their portfolio.

In addition, a new development over the past few years has been the advent of the robo-advisor. These automated software platforms, often available as mobile apps, take care of nearly all your investment decisions at reduced costs.

Arguably the first robo-advisor—and first to offer cryptocurrency portfolios—Betterment launched in 2010 after the Great Recession. Since then, robo-advising has seen exponential growth in adoption and a flurry of startups and existing brokerages adding a robo-advisor arm.

Human Brokers and Financial Advisors

Some people prefer to have a human handle their finances. If this is you, then a traditional advisor may be a better fit than a robo-advisor. Human brokers and financial advisors have been around since the beginning of modern stock markets, and they've carved out space in today's competitive landscape by catering to investors with a higher net worth or those who prefer human interaction.

Good financial advisors build and monitor investment portfolios and offer advice in many aspects of their clients' financial lives. They also provide auxiliary services such as insurance, estate planning, accounting services, and lines of credit.

Customers of these brokers can expect to pay 1% or more of their assets under management to the advisor; sometimes, they may pay up to $50 per trade for individual transactions. Many advisors claim that these fees are well worth the extra value they bring, such as picking stocks for their clients’ portfolios, accessing unique products and offerings, or building comprehensive financial plans.

When comparing brokerages, pay attention to what the advisor is telling you. The brokerage may require them to push prepackaged investments, funds, or financial plans; if this is the case, make sure you ask about building a plan that fits your needs.

Also, pay attention to fees. If they're charging more than 1%, ask why and judge for yourself whether the extra cost is worth it. Professional certifications such as the Certified Financial Planner (CFP) or Chartered Financial Analyst (CFA) designation show that your broker has been trained and has passed a series of rigorous exams related to financial markets and planning.

You could also use FINRA's BrokerCheck tool to see if the broker has been subject to regulatory complaints or ethics violations.

Online Self-Directed Broker Accounts

Online self-directed platforms include E*TRADE, TD Ameritrade, Robinhood, and many others. Be sure to check your bank—you may already have access to a self-directed online brokerage account.

For the most part, these platforms leave it up to you to figure out which investments are the best, but they typically offer a suite of research and analysis tools. Many provide expert recommendations and insights to help you make informed decisions. You are then on your own to execute the trades to build your portfolio through their website or mobile app.

These platforms may charge a per-transaction commission per stock trade and extra per options contract. However, zero-commission trades have become the norm among discount brokers in recent years. In addition, they let you trade on margin and create options strategies. You can also invest in mutual funds, individual stocks, foreign exchange (forex), and exchange-traded funds (ETFs).

Online brokerages are best for the self-directed investor who knows about the markets or conducts research to choose a portfolio best suited to their goals. If you're only going to make a few trades a year, you may want to pay a little more per trade to get access to higher-quality research and analysis. If you're a day trader, you'll probably want to consider a site that gives its most active users free trades.

Robo-Advisors

Robo-advisors automate investing and use technology to manage your portfolio. Since Betterment launched in 2010, there has been a proliferation of startups and existing financial companies offering this algorithmic trading service.

Unlike the trading algorithms that power the high frequency trading (HFT) desks at hedge funds and banks, robo-advisors are likely to put your money to work using low-cost, indexed ETFs. In fact, the convergence of ultra-low-fee ETFs with low-cost technology solutions available on mobile platforms makes robo-advising possible.

Before robo-advisors, if you had only a few hundred or thousand dollars to invest, you'd have to go online to a self-directed platform. Now, you can put $200 or $2,000 to work without having to conduct any investment research, pick any individual stocks, or worry about rebalancing your portfolio.

Algorithm-based robo-advisors aim to place you in an efficient and diversified passive portfolio. The best robo-advisors will even tax-optimize your portfolios with tax-loss harvesting, a process by which an investor sells losing positions to offset the capital gains generated by winning positions. The algorithms themselves are a proprietary company secret of robo-advisors.

Robo-advisors are ideal for new or young investors who don't have much to invest. These platforms are also suitable for people who are fans of passive investment strategies because your robo-advisor develops a portfolio of indexed ETFs on your behalf.

Robo-advisors also shine for those long-term investors who lack the time or desire to research and find the ETFs that meet their investing needs and strategy.

But robo-advisors are certainly not for everyone, as they may not provide access to more complex products and strategies embraced by some investors. Many brokerages are adapting their robo-advisors to allow for more customization in their portfolio choices.

If you choose a robo-advisor, the factors to consider are primarily cost, reputation, and added services. Ensure that you monitor the cost of extra services: some are free, but others might add extra costs.

The Bottom Line

From traditional full-service firms with centuries of history to established online brokers to newer upstarts challenging the paradigm, you have a huge array of options when choosing a brokerage account. Some of the most important factors to consider include the level of services and support you need as well as the amount you have to invest.

If you have a lot of assets or would like more personalized guidance, it may be worth working with a traditional financial advisor. Meanwhile, a robo-advisor might be ideal if you're looking for more limited direction with lower fees. Finally, if you're comfortable doing the legwork on your own, you can invest via a self-directed account. No matter which type you choose, your brokerage account can become a key vehicle for growing your wealth and reaching your financial goals.