Perhaps the biggest difference between brokerage accounts and mutual funds is their structure. While brokerage accounts allow you to buy investments, mutual funds are investments themselves. Each has its pros and cons. 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 securities, such as stocks and bonds. It’s common for this kind of account to be opened through a broker. You can also open an account through a discount broker. Brokerage accounts can be owned by one person or jointly owned by two or more people.
What Is a Mutual Fund?
A mutual fund pools the assets of many investors into one portfolio, which is then run by a professional manager. 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 even hundreds of holdings.
Similarities Between Brokerage Accounts and Mutual Funds
There are a few key ways that brokerage accounts and mutual funds are alike.
Diversification and Flexibility
Brokerage accounts and mutual funds both can provide broad diversification, which means they can hold many types of assets and asset classes. With your brokerage account, you choose how diverse your holdings will be. For instance, you may hold many types of stocks, or you may have many kinds of assets. Or you can choose to put all of your eggs in one basket, so to speak, by only holding one type of asset, or you may choose to own only stocks from one sector. You choose your goals and how you will fulfill them. Mutual funds can also be broadly diversified or narrowly concentrated. Some funds hold many types of assets, or they may include stocks from many sectors. They may have a range of market caps. On the other hand, you may find funds that hold assets with quite a narrow focus, as well. And, you may choose to invest in one mutual fund or many funds.
Taxation
Although there are some small details that differ, brokerage accounts and mutual funds are alike in many ways when it comes to taxes. For instance, the income you earn from interest, the dividends you are paid, and the short-term capital gains you receive are all taxed as ordinary income. You’ll pay a lower tax rate on long-term capital gains (from holding a security longer than one year) and on qualified dividends.
Professional Management
If set up through a full-service firm, brokerage accounts can be professionally managed. That means a broker or advisor can buy and sell securities on your behalf. They can also advise you on what action to take. Mutual funds are also professionally managed. There are funds with active management, where someone is paid to buy, sell, and manage securities within the fund. There are also funds that are passively managed. An index fund is one such example. No one buys and sells the assets held in an index fund. Instead, an index fund is made to mirror a larger index, such as the S&P 500. Passive management has lower fees and costs than active management, mainly because no one takes a salary or commission to manage the fund.
Differences Between Brokerage Accounts and Mutual Funds
There are also a few ways that brokerage accounts and mutual funds differ. These include their structure and the fees and costs that go with them.
Structure
Brokerage accounts are not investments. They are accounts that hold investments. Mutual funds are investments that you can buy using an account. That account may be a brokerage account, an IRA, a 401(k), or a variable annuity. You can also buy the fund right from a mutual fund company.
Opening Costs and Minimums
You can open a brokerage account with no startup costs or fees. If you want to buy a mutual fund, you may find you need to have a minimum initial investment. These are often in the range of $1,000 to $3,000, but this amount may be higher.
Ongoing Fees
Fees work differently for brokerage accounts and mutual funds. For example, the fees for a brokerage account mostly consist of trading costs, such as transaction fees or commissions. Using a typical broker will likely cost you more than using a discount broker. If you choose a discount broker, you may even be able to make trades for free. Mutual funds often 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. The average expense ratio is around 0.45%.
Bottom Line
Looking at brokerage accounts vs. mutual funds is like looking at apples and oranges. They are alike in some ways. In the end, though, they are not at all the same thing. Brokerage accounts are holding vehicles for investments. Mutual funds are investments themselves. In fact, mutual funds can be held within a brokerage account. If you want to be able to invest in many types of securities, you may want to open a brokerage account. If you plan to invest in mutual funds, you may be able to lower costs if you buy straight from a no-load mutual fund firm such as Vanguard or Fidelity.
