Brokerage Account vs. Mutual Fund

Brokerage accounts offer more flexibility and control over individual investments, while mutual funds offer diversification and professional management for a hands-off approach to investing.

Before you start investing, you’ll have to nail down some key terms and concepts, including the differences between a brokerage account and a mutual fund account. Read on to learn the difference and how each plays a part in your investing strategy.

What is a Brokerage Account?

A brokerage account is a type of investment account that allows you to buy and sell stocks, bonds, mutual funds, ETFs and other types of investments. Brokerage accounts are typically opened with an online broker or a traditional stockbroker, and they can be used to create a diversified portfolio to help you reach long-term financial goals. With a brokerage account, you have access to research and tools to help you make informed investment decisions.

Full-Service vs. Discount Broker

The type of broker you sign up with will determine the services available to you.

An account at a discount broker would likely have low commissions but not much customer service.

A full-service brokerage offers more services and could potentially give you access to anticipated initial public offerings (IPOs) if you have a big account or use its services a lot.

Choosing a Margin or Cash Account

Two types of broker accounts are generally available: a cash account and a margin account.

Investors using cash accounts must wait three days until a transaction settles before initiating another transaction. 

If you’re using a margin account, the brokerage loans you money and allows you to do the transaction instantaneously. You must pay interest that you borrow, which at most brokerages is generally 7% or higher for accounts less than $100,000. You can short in a margin account but not in a cash account, but shorting is considered dangerous.

Day traders must have at least $25,000 or they will run into the pattern day-trading rule that prohibits them from making more than three round-trip trades in one week. 

Different Types of Securities You Can Buy

A brokerage account can be used to buy different types of securities, including common stocks, bonds and mutual funds.

Common stocks are fractional ownership of a company. If the company makes a profit and the company’s management decides to share it with stockholders, the company could pay a quarterly dividend to investors. The dividend would go into the brokerage account on the ex-dividend date.

Bonds include things such as Treasury bills, municipal bonds and corporate bonds. Because the U.S. government backs them, short-term Treasury bills are considered the safest securities in the world. Municipalities issue municipal bonds, which can be tax-free.

Depending on how strong a company is, corporate bonds can be safer than stocks of the same company. Many bonds pay a coupon or periodic interest payment that continues until the bond matures. The periodic interest payment also goes into your brokerage account.

Opening a Brokerage Account

To open a brokerage account, fill out an online application or visit a physical location. After you are approved, you must fund the account through an Automated Clearing House (ACH) or check wire transfer. 

Unlike 401(k)s, individual retirement accounts (IRAs) and other retirement plans, there is no restriction on how much money you can put in a brokerage account. You should check how strong the brokerage is and whether it has Securities Investment Protection Corp. (SIPC) coverage. SIPC coverage is insurance that protects investors to a certain limit if the stock brokerage firm goes under.

What is a Mutual Fund?

A mutual fund is a managed portfolio of the stocks or bonds of many companies. Because multiple companies comprise a mutual fund portfolio, it may be lower risk than owning stock in a single company.

If things go wrong in one company, other companies in a mutual fund portfolio still could do well, and the mutual fund’s overall value won’t be as negatively affected. 

Professional Management

Mutual funds typically have a portfolio fund manager who directs stock market research analysts. The team picks stocks they think will outperform an index, such as the S&P 500, and include it in their portfolio.

Some mutual funds are concentrated in a sector such as energy or technology, while others cover the stock market as a whole. Because professional investment managers make the buy and sell decisions, mutual funds are considered active funds.

Fees

Many mutual funds charge management fees ranging from 0.5% to 2% per year. Many mutual funds also charge redemption or purchase fees when an investor exits and enters the fund.

Historical Performance

Although many mutual funds have outperformed the market for long stretches of time, the statistics on broader active fund performance versus the broader market is sobering.

According to a Standard & Poor’s research report, 92.2% of large-cap active funds, 95.4% of mid-cap active funds and 93.2% of small-cap active funds have lagged behind a simple index fund that only tracks the S&P 500.

The data suggests that although owning a mutual fund is more beneficial long term than holding onto cash, owning a simple low-cost S&P 500 index fund could be a better choice.

Many mutual funds lag the index because of their fees as well as short-term buying and selling, which creates more taxable income than a buy-and-hold strategy.

You Need a Brokerage Account First

You usually need a brokerage account before you can buy a mutual fund unless your employer offers a retirement plan.

Looking for an online broker so you can start investing through a brokerage or with a mutual fund account? Check out our guide on how to start investing, online brokerage rankings or our picks for the best portfolio trackers.

Successful Investing

Understanding the differences between a brokerage account and a mutual fund account is important in investing. A brokerage account allows buying and selling of individual stocks, while a mutual fund offers a professionally managed portfolio. Factors such as fees and performance should be considered when choosing between the two. Making an informed decision is crucial for a successful investment journey.

Frequently Asked Questions