Time for the nuts and bolts – information critical to pursuing early retirement. The topic of this post is how to set up a brokerage account, one of the first steps in the process. If it seems like a very basic step, you’re right, it is. And some of you reading this might be thinking: does it really take an entire post to explain this? The answer I’ll give you: not necessarily. But like every other topic, it can ease the process to gain more knowledge about it, and this post discusses not just how to open an account, but ways to fund it and how to use it. Below I discuss background information on the concept of investing, how to use a brokerage account, and some basic features of brokerage accounts that are helpful to enable from the start.
Starting with the most fundamental of topics, what does it mean to invest? It’s a broad term that generally means to acquire something of value that can increase your net worth. When we think of investing, we mostly think of acquiring an asset that itself increases in value, but that’s not necessarily always the case. We can acquire something that may have either an intangible value (like an education) or a declining value (equipment), but can generate income from its application or use. If FIRE is the goal, however, I’m mostly talking about stock market investing. It’s relatively easy, it’s passive, over the long-run requires little attention (not to say you won’t pay attention every minute of the day), and tends to produce the sort of returns needed.
It’s at this point I should again make it abundantly clear that I’m not a financial advisor. I’m not registered with any licensing agency that licenses or supervises the financial industry, nor do I have formal training or anything of that nature in financial markets or even finance generally. In no way should you take what I’m saying as sound financial advice about your particular situation. My goal is to share what I’ve learned from investing in the market and how I’m planning to meet my FIRE goals.
Everyone has to consider their own circumstances when deciding to invest, especially in the stock market, as, let me be clear: YOU CAN LOSE YOUR MONEY. Stock (and other asset) prices decline due to any number of known and unknown reasons, companies go bankrupt, and on and on. It is absolutely imperative that you conduct your own research when deciding to invest, and thankfully the SEC mandates that publicly-traded companies produce an abundance of it. If you need to, hire a real financial advisor and keep a close eye on them. Got it?
With that out of the way, let’s talk about how we actually go about this thing called investing. So you’ve managed to start saving by foregoing your monthly trips to the spa, or the caviar factory, or maybe you’re buying fewer pairs of shoes, or just doing something realistic like tightening your spending. However you choose to save money is the subject of numerous separate posts, but if you’re able to do it (at least in part) – great! Now what to do with that extra money that you don’t need every month to pay the bills.
The first thing I do with the money I’ve earmarked for retirement funds is to get it out of the checking account I use for everything else. Seeing it in there gives a false sense of having it available to spend – the exact opposite of the way we want to see this money – for now. The net worth you save needs to be separated and locked away, a chest to be opened only when it becomes your primary source of sustenance.
And of course, you can’t trade stocks in a checking account. The most you’ll get by keeping it in the bank is a fractional (and I mean fractional – think 0.01% – 0.1% APY, which is about $1-$10 per year on a $10,000 balance) return, and that’s if your bank even offers interest on checking accounts. Side note, for a while, banks were prohibited by federal regulation (Regulation Q) from paying interest on checking accounts. While banks are no longer prohibited from paying interest on checking accounts, you see that they’re not particularly generous with it.
So how do you hold the money you’re saving and investing? Find yourself a brokerage account. Nowadays there are plenty to choose from. Fidelity, E-trade, TD, Chase, Schwab, T. Rowe Price, etc. You can’t throw a stone on the internet without hitting a brokerage account. What are the odds that there’s an ad for one now on the side of the screen based on this text? They’re all relatively simple to open. Usually you can fill out the forms online, or their customer service will send them to you by mail. Typically it takes a few days to get the account up and running after you’ve completed all the paperwork due to the time they need to verify your identity. This means that you shouldn’t expect to be trading immediately after opening the account, but it generally does not take all that long.
The important things to look for in a brokerage account include no account-holding fees, no commissions on stock trades, no minimum balance, easy access to funds, decent customer support, and a good app. They all essentially offer the same thing so choose the one that’s right for you.
If your employer set up a 401(k) for you, they’ll generally hold the investment with one of these major firms. If you’re happy with the interface, you may consider opening a separate account there for personal investing so that you can see your total balance when you log in. If you’re searching for an account now, be aware that most of them have introductory offers that include a cash infusion for transferring in a certain balance – a nice opportunity for some additional cash. No commission fees for equity trades is a relatively new feature as of about 2019, and one that I love; eliminating these transaction costs can save a great deal of money over the long-run.
Keep in mind that the decision to select an online brokerage account assumes that you’ll be self-investing; as in, not using a money manager or financial advisor for all or part of your savings. If using an advisor, there’s a different vetting process for that, which is the topic of a separate article. I will mention, however, that the popular brokerage firms offer financial advisory services, and of course, will hold your money in the firm’s accounts. If you work with an independent advisor, they’ll usually have a go-to “custodian” where they hold your money and conduct transactions. More often than not, it’s one of the large brokerage firms.
Once your brokerage account is up and running, you have to start funding it. Most brokerage accounts allow you to fund with direct Electronic Funds Transfer (EFT) from a bank account, which is usually the quickest way to move funds and typically does not carry a fee for small amounts (though check with your bank before concluding this). Some brokerage accounts allow you to set up recurring transfers, where the account will automatically schedule an EFT on a pre-set interval of your choosing. This option might be good to force yourself to move money, but you have to keep a close eye on the balance of the account from which the automatic EFT is drawn. Overdrawing your account can be an expensive mistake both from the fees your bank will charge plus the possible inability to pay other bills drawn from that account. (Note here: do not confuse an EFT with an ETF. An ETF – Exchange Traded Fund – is a type of asset that I discuss in other posts).
I transfer money manually from each paycheck. This way, not only can I adjust the amount based on how much I think is appropriate, but can make sure I have the liquidity I need in my checking account to pay bills. Another option I’ve always considered but haven’t chosen to implement yet is having a portion of each paycheck direct-deposited by my employer into my brokerage account. Most employers will allow you to split your direct deposit into multiple accounts and are fairly flexible in how you arrange it. You could direct-deposit a specific amount or percentage to the brokerage account, with the remainder into your checking account. Again, this is another great way to force yourself into saving. By never seeing the money in your checking account in the first place, it’s as if it never existed for you to spend. In fact, this is part of the theory behind employee 401(k) accounts – take it directly out of your pay and sequester it by imposing a penalty for spending it until you hit 59 ½. A personal brokerage account takes more self-imposed discipline – remember that!!
EFT is not the only way to transfer funds. Most brokerages allow you to fund by writing a check to the account, or you can deposit a check made out to you. If the firm has a brick and mortar location (as increasingly rare as this is), you can show in person like you would a bank and deposit the check that way. Simpler than that, once you have the app (see below), you can usually deposit checks up to a certain amount directly on the app, much like most banks now allow you to do. Long story short, the big brokerage firms have made it pretty easy to deposit money into your accounts.
Most brokerage firms I’ve worked with have fairly decent customer service and can guide you over the phone through any of the steps above. They can walk you through setting up the account, linking a bank account to fund it, and can provide the information you need (such as the routing number) if you want your employer to direct deposit a portion of your paycheck into the account.
As soon as you’re set up, download the brokerage’s app for your phone. The apps are a great way to check balances, and in most of them you can schedule EFTs, deposit checks, and even place trades. In fact, I can’t think of a single transaction I’ve performed on my laptop/desktop in the past few years. All my EFTs and purchases take place on my phone – sure beats the old days when you had to speak to a broker over the phone to place trades after looking up yesterday’s closing price in the newspaper.
Something you’ll need to select when you set up your brokerage account is what to do with the uninvested cash that sits in the account. This may be money you’ve transferred in but have not yet used to purchase assets, or it may be cash from dividend payments and other transactions. Most brokerage firms will hold that money in an interest-bearing fund until you use it, but some of the firms have more than one and they’ll ask you which one you want to use. For the most part, they’re fairly similar and there’s little variation between the minimal interest you’ll earn on those uninvested funds, but be prepared to select one when you open the account.
One final point, and something you should do immediately – even before funding your account, is to enable two primary security features on your account. The last thing you want is someone siphoning funds out of a brokerage account and putting you through the process of trying to retrieve them.
First, and this is applicable for almost every account you have (brokerage or otherwise), is to enable dual or two factor-authentication. You know what this is from your e-mail or your bank account or your grocery store loyalty card. First you enter your password and then they send a code by text or e-mail to your phone that you’ll have to enter to access the account. This is an absolute must. It turns out it’s remarkably simple to steal your password, so this extra layer of security is absolutely fundamental.
Second, once you’re in the account itself, enable a transfer-out lockdown. Different brokerages call it a different name, but essentially it’s a feature that disables transfers out of your account. That way, if someone gets a hold of your routing and account number, they can’t start drawing funds from it. The would-be thief would also have to have your account login and a way to bypass your two-factor authentication to shut off your security lock – which would trigger another notice to you, hopefully giving you the opportunity to stop any transaction before the theft occurs. Don’t put in any money until you’re sure that you can’t get it out!
Now that you’re set up, funded, and safe, it’s time to start investing. Other posts will lay the groundwork for some basic information about the approach to investing in stocks and other assets in pursuit of FIRE.
The FIRE Investor's Guide to Early Retirement 