The Advantages of a Taxable Brokerage Account
Choosing the right account to hold your investments is part of the wealth-creation process. Investment accounts are often grouped into either tax-deferred retirement accounts, such as 401(k) plans and Individual Retirement Accounts (IRAs), or straight taxable brokerage accounts. Although these accounts levy annual taxes upon interest, dividends and capital gains, taxable brokerage accounts do carry distinct advantages. Taxable brokerage accounts offer liquidity, infinite investment choice and the potential to exploit sophisticated trading strategies for large gains, which may exceed the tax benefits of retirement plans.
Other People Are Reading
-
Liquidity
-
Liquidity describes your ability to convert any asset into cash, in-hand. Retirement accounts often place age restrictions upon when you may actually access your money. As of 2010, IRAs and 401(k) accounts cannot be liquidated before you turn age 59 1/2, without a 10 percent penalty on the balance. For early withdrawals on retirement plans, you will pay this 10 percent penalty in addition to ordinary income taxes. Taxable brokerage accounts, however, can be liquidated for cash at any time, without penalty. You may need to access these taxable brokerage account funds to provide financial relief, in case of emergency situations, such as hospitalization and job loss.
Investment Choice
-
Taxable brokerage accounts provide access to all investments classes within the financial universe. Assets that you may buy include penny stocks, preferred shares, international equities, municipal bonds, mutual funds and certificates of deposit. These distinct investment choices allow for effective diversification, while also introducing you to unique securities that offer exceptional rates of return. Retirement funds, however, feature more limited investment choices. For example, your 401(k) plan may only offer ten different mutual funds, alongside offers to purchase company stock at a discount. Having fewer investment options reduces your chances for large gains.
-
Sophisticated Trading
-
Taxable brokerage accounts enable you to implement sophisticated trading strategies, with the help of margin loans, short selling and derivatives. Trading on margin refers to the process where brokerages make loans against your account balances to increase your buying power for investments. To profit, you leverage these loans to buy investments that earn higher returns than the associated interest payments charged on the margin debt. Margin accounts also introduce shorting capabilities. Short sales are executed when you borrow stock and immediately sell those shares for cash. At a later date, you buy to cover, or repurchase, the shares in the stock market to replace the original stock loan. Short selling makes money when stocks actually lose value.
Derivatives, such as options and futures, are risk management products that derive their value from the price fluctuations of other assets. Stock options grant you the choice to buy and sell investments at predetermined price points over a certain time frame. Alternatively, futures contracts require traders to accept agreed-upon asset prices at future dates. Beyond locking in investment prices, derivatives may be traded for a profit. Futures and options increase in value when financial markets are especially volatile.
-
References
Resources
- Photo Credit dollar bill image by jimcox40 from Fotolia.com
