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.

Margin Account vs. 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.

Brokerage Account vs. Mutual Fund: Similarities

When investing, it is important to understand the differences between financial vehicles. Brokerage accounts and mutual funds are two popular options for growing wealth. They serve different purposes but share similarities. Both allow access to the stock market and other investment opportunities. This helps investors diversify their portfolios and manage risk. Each option has unique advantages regarding liquidity, investment strategies, and potential returns. Understanding these similarities can help investors use both options effectively. This way, they can tailor their approach to their financial goals and risk tolerance.

Broad Range of Investment Options

Both brokerage accounts and mutual funds provide a variety of investment options. This allows investors to create portfolios that match their financial goals and risk levels. In a brokerage account, investors can buy individual securities like stocks, bonds, and exchange-traded funds. This gives them the flexibility to choose the specific assets they want. Mutual funds, however, collect money from multiple investors to invest as a group. They typically invest into a mix of assets, including stocks and bonds. While you do not select each security personally, you can choose a fund that fits your goals, such as growth or income. Both accounts help spread risk through diversification across different asset classes.

Potential for Long-Term Growth

Brokerage accounts and mutual funds help investors grow wealth over time. A brokerage account allows you to invest in individual securities. These investments may increase in value. You can also earn dividends from stocks and interest from bonds. Reinvesting these earnings can enhance your portfolio’s growth potential. Mutual funds also aim to generate returns. They do this through capital appreciation, dividends, and interest payments. Many mutual funds automatically reinvest dividends and interest back into the fund. This compounds your earnings. Both brokerage accounts and mutual funds focus on long-term financial growth. However, their management and approaches to achieving that growth differ.

Costs and Fees Associated with Investing

Both brokerage accounts and mutual funds come with costs that can affect overall returns. In a brokerage account, investors pay transaction fees each time they buy or sell securities. These fees can add up based on how often trades occur. Some brokerage accounts may also have maintenance or annual fees. Mutual funds charge management fees and expense ratios to cover operational costs. These fees are expressed as a percentage of the assets under management. They are automatically deducted from the fund’s returns. Mutual funds typically do not have transaction fees for individual trades. However, the expense ratios can significantly impact returns, especially for long-term investors. It is important for investors to understand the fees associated with their investment choices. They should consider how these fees might reduce the overall value of their portfolio over time.

Brokerage Account vs. Mutual Fund: Key Differences

Understanding the differences between a brokerage account and a mutual fund is important for investors. A brokerage account allows for buying and selling a variety of securities, such as stocks, bonds, and ETFs. This gives investors a hands-on approach to managing their investments. In contrast, a mutual fund combines money from multiple investors to create a diversified portfolio. This portfolio is managed by professionals, making it easier for investors to access diversified investments without needing extensive market knowledge. Both options have advantages and cater to different investment styles and goals. This comparison will explore the key differences, unique characteristics, and suitable use cases for brokerage accounts and mutual funds.

Ownership of Assets

Ownership of assets differs between brokerage accounts and mutual funds. In a brokerage account, you directly own the individual securities you choose. This may include stocks, bonds, ETFs, or other assets. With direct ownership, you have full legal and economic rights. You can vote in shareholder meetings for stocks. You also receive dividends or interest directly. Additionally, you control when to buy or sell those assets. In contrast, investing in a mutual fund means you do not own the individual securities within the fund. Instead, you own shares of the mutual fund itself. The mutual fund owns the underlying portfolio of securities. While you can benefit from the fund's growth or income, you do not have direct ownership. There are also no voting rights over the individual assets held within the fund.

Control Over Investments

Brokerage accounts offer complete control over investment decisions. Investors can choose, buy, and sell specific securities as they wish. This allows for long-term holdings or frequent trades based solely upon market conditions. A brokerage account is suitable for hands-on investors who want to manage their portfolios actively. In contrast, mutual funds are managed by professionals. Fund managers or teams decide which securities to buy, sell, or hold. They base their decisions upon the fund's objectives and strategy. As an investor in a mutual fund, you have no control over the specific assets or trade timing. Instead, you depend upon the fund manager's expertise, which is suitable for those who prefer a passive investment strategy.

Diversification

Mutual funds offer built-in diversification. They pool money from many investors to buy a variety of assets, such as stocks and bonds. This diversification reduces the risk that one poor-performing asset will greatly affect the fund's overall performance. For example, if one stock does poorly, gains from others may offset the losses. This helps stabilize returns. Investors find mutual funds to be an easy way to achieve a diversified portfolio without having to buy many securities individually. In contrast, diversification within a brokerage account is entirely up to the investor. While a brokerage account allows for complete customization, the level of diversification depends on the investor's choices. If an investor holds only a few stocks or bonds, they risk greater exposure to the performance of just these assets. This can increase overall risk. Achieving the same diversification as a mutual fund would require active management and careful balancing of various investments.

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