When comparing brokerage accounts to mutual funds, investors should learn the key similarities and differences before investing. Each investment vehicle has its advantages and disadvantages. Find out which one is best for you or if you may need both.
What Is a Brokerage Account?
A brokerage account is an account that is used by investors to buy, sell and hold investment securities, such as stocks and bonds. Brokerage accounts can be opened through a conventional full-service brokerage firm or through an online discount broker. Ownership of brokerage accounts can be on an individual basis or they may be owned jointly.
What Is a Mutual Fund?
A mutual fund is a pooled investment security that combines assets of multiple investors into one professionally managed portfolio. Mutual funds can invest in stocks, bonds, cash or a combination of these assets. In this regard, mutual funds are like baskets that may have dozens or hundreds of holdings.
Brokerage Accounts vs. Mutual Funds: The Similarities
There are a few key similarities between brokerage accounts and mutual funds. Although the similarities are subtle, investors should understand them before investing.
Here are the key similarities of brokerage accounts and mutual funds:
- Diversification and Flexibility: Brokerage accounts and mutual funds can provide broad diversification, which means multiple security types can be held within each investment vehicle. However, the degree of diversification is up to the investor. For example, brokerage accounts can hold multiple security types but the investor may or may not choose to diversify across multiple asset types or investment objectives. Similarly, mutual funds can be broadly diversified or narrowly concentrated. The investor may choose to invest in one mutual fund or multiple mutual funds.
- Taxation: Although the nuances of taxation can vary slightly between brokerage accounts and mutual funds, there are key similarities: Interest and dividends are taxed as ordinary income and investors pay taxes on capital gains.
- Professional Management: If purchased through a full-service brokerage firm, brokerage accounts can be professionally managed, which means a broker or advisor can recommend, buy, and sell securities on behalf of the investor. Mutual funds are also professionally managed, although some are passively-managed funds, such as index funds.
Brokerage Accounts vs. Mutual Funds: The Differences
These differences will be key factors in deciding which investment vehicle is best. Here are the key differences between brokerage accounts and mutual funds:
- Structure: Perhaps the biggest difference between brokerage account and mutual funds is their purpose and functionality, which combine as the structure. Brokerage accounts are not investments; they are accounts that hold investments. However, mutual funds are not accounts. Although they do hold securities, the investor will buy the mutual fund inside an account, which may be a brokerage account, an IRA, a 401(k), a variable annuity, or directly through a mutual fund company.
- Opening Costs and Minimums: Brokerage accounts can be opened with no initial costs or fees to the investor. However, mutual funds often have minimum initial investments, which can range from as little as $100 to as much as $3,000 or higher.
- Ongoing Fees: After opening the account or buying the mutual fund, the ongoing fees can be different. For example, the fees for a brokerage account primarily consist of trading costs, such as transaction fees or commissions. If you use a broker, commissions are generally higher than if you do it yourself through a discount broker. Mutual funds can have sales charges, called loads. There are also no-load funds that do not have sales charges. However, all mutual funds have ongoing expenses that are expressed in the fund’s expense ratio, which typically averages around 1.00%.
Bottom Line on Brokerage Accounts vs. Mutual Funds
Comparing brokerage accounts and mutual funds is an “apples-to-oranges” comparison; they are related but not at all the same thing. Brokerage accounts are holding vehicles for investments, whereas mutual funds are investments themselves.
In fact, mutual funds can be held in brokerage accounts.
If you want the flexibility of investing in multiple security types, you may want to open a brokerage account. But if you want to invest in mutual funds, it is often best to buy directly from a low-cost, no-load mutual fund company like Vanguard or Fidelity.