Brokerage Account vs. Mutual Fund: Which is Best For You?

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SmartAsset: Brokerage Account vs. Mutual Fund

Comparing mutual funds and brokerage accounts is a little like comparing apples and oranges. While mutual funds are professionally managed investment products, brokerage accounts are used for purchasing individual securities, including mutual funds. Below, we’ll break down each of these terms and explore what sets them apart from each other. For help selecting mutual funds or managing your portfolio through a brokerage account, consider working with a financial advisor.

What Is a Mutual Fund?

A mutual fund is a professionally-managed investment fund that pools money from members of the public and invests it in a variety of securities, including stocks, bonds and other assets. Investing in a mutual fund offers greater diversification compared to buying individual shares of company stock, as it spreads your money across multiple companies, industry sectors and asset classes.

However, there’s a wide range of mutual funds from which investors can select. According to the Investment Company Institute, there were more than 9,000 mutual funds registered in the U.S. by the end of 2020. Some funds seek to maximize capital gains, while others primarily invest in companies that generate dividends. Some may exclusively hold either stocks or bonds, while balanced funds have portfolios that comprise both. A fund can also be highly specialized and only invest in a certain sector, like real estate or energy, or seek to capture the returns of the larger market.

Mutual funds also vary based on the type of investment management they offer. Actively managed funds have investment managers responsible for selecting the fund’s underlying assets and conducting trades on behalf of the investors. Passively managed funds, on the other hand, track particular indexes, like the S&P 500 or Nasdaq. These funds do not aim to outperform the market. Instead, they seek to mirror a specific index and duplicate its performance. As a result, passive funds often have lower fees and result in fewer transactions than their active counterparts.

However, diversification and professional management come at a cost. Mutual funds charge their shareholders what’s known as expense ratios, a percentage of your total account value that’s removed annually in management fees. For example, if you had $10,000 invested in a fund with a 0.50% expense ratio, you’d pay $50 in annual fees.

What Is a Brokerage Account?

SmartAsset: Brokerage Account vs. Mutual Fund

A brokerage account is a taxable investment account that can be used to buy and sell stocks, bonds, mutual funds and other securities. Some brokerage accounts also allow investors to deal in futures, options, trade on margin or invest in initial public offerings (IPOs).

Brokerage accounts are also referred to as taxable accounts since the profits realized from the sale of securities within them are subject to capital gains tax, while assets that earn interest or generate dividends are also taxed. This is different than a tax-advantaged retirement account, like an IRA for 401(k), which defer taxes until money is withdrawn.

Brokerage accounts can be opened through a traditional full-service brokerage firm, a fiduciary financial advisor or online through a robo-advisor or discount broker. The cost of opening and maintaining a brokerage account will vary based on where the account is held.

Brokerage Account vs. Mutual Fund: Key Differences

Understanding the key differences between brokerage accounts and mutual funds is especially important for new investors. Brokerage accounts and mutual funds are structured differently, charge investors different types of fees and offer varying degrees of asset selection. Here’s a breakdown of four key differences:

Structure: The primary difference between mutual funds and brokerage accounts is their structure. While the former is a type of investment product, the latter is an account for buying and selling securities. In other words, brokerage accounts can be used to buy and sell mutual funds, but mutual funds can’t be used as brokerage accounts.

Fees: As mentioned above, mutual funds charge their shareholders fees in the form of expense ratios. People with traditional brokerage accounts, on the other hand, typically pay transaction fees and/or trading commissions. Those with brokerage accounts through fiduciary financial advisors typically pay an asset-based advisory fee in addition to the expense ratios charged by the mutual funds in their portfolios. A robo-advisor, on the other hand, is a cost-effective way to invest, since these platforms use algorithms to build and manage investment portfolios. These digital advisors typically charge annual fees of around 0.5% of assets under management, compared to the 1-2% charged by many human advisors.

Asset selection: While there is a diverse and wide-ranging pool of mutual funds, investors do not have the option of selecting individual securities within a fund. Whether a mutual fund is actively- or passive-managed, its investors cannot allocate their assets to certain holdings within a fund and avoid others. This is different from a brokerage account, which offers the investor total control over their assets. This includes the option to buy and sell individual securities at their leisure, as opposed to relying on a fund manager or an index to tweak the underlying holdings of a fund. Then again, many investors don’t mind forfeiting that level of control in exchange for the convenience and efficiency of a mutual fund. That’s why many invest in mutual funds through brokerage accounts.

Minimum investments: While many brokerage accounts typically don’t have a required minimum investment size, mutual funds often do. These minimums can be as little as $500, but the average fund typically requires a minimum investment of $2,500. Then again, that doesn’t apply to all fund companies. Fidelity, for example, does not require a minimum account size for investors buying its mutual funds.

Brokerage Account vs. Mutual Fund: Key Similarities

SmartAsset: Brokerage Account vs. Mutual Fund

Despite these fundamental differences, brokerage accounts and mutual funds also share three significant similarities:

Diversification: An investor can build a diversified portfolio by either buying mutual funds or opening a brokerage account. An investor solely interested in owning mutual funds can own index funds that track the market as a whole or multiple funds that focus on individual sectors or industries. The same level of diversification can be achieved using a brokerage account, by either investing in mutual funds, exchange-traded funds or individual securities. If an investor opts to pick individual securities, it will likely require much more research, time and energy to compile an adequately diversified portfolio, but it can be done.

Taxation: For the most part, mutual funds and brokerage accounts are taxed the same way. Assets that are held for under a year before being sold are subject to short-term capital gains taxes, while those held for more than a year before being sold are taxed at the more favorable long-term capital gains rate (0%, 15% or 20% depending on the investor’s federal income tax bracket).

Meanwhile, ordinary dividends are taxed as ordinary income, meaning an investor must pay federal taxes on the income at their regular rate. Qualified dividends, on the other hand, receive the same tax treatment as long-term capital gains.

Professional management: Mutual funds and brokerage accounts both offer some level of professional management. Mutual funds, especially those that are actively managed, have financial professionals selecting securities and making transactions that affect the net asset value of the fund. With the exception of self-directed accounts, brokerage accounts can also be professionally managed, either by a broker or a financial advisor. Many financial advisors offer both discretionary and non-discretionary asset management. The former grants the advisor authority to make trades within a client’s account, while the latter requires the client to sign off on individual transactions and maneuvers.

Bottom Line

When comparing mutual funds and brokerage accounts, it’s important to understand that mutual funds are investments in and of themselves. Brokerage accounts are places where investors can buy and sell securities, including mutual funds. Mutual funds and assets that are held in a brokerage account are generally taxed in the same manner. However, mutual funds often require a minimum investment but brokerage accounts generally do not.

Tips for New Investors

  • Need help with your portfolio? A fiduciary financial advisor can build a portfolio for you that aligns with your financial goals and time horizon. Finding a qualified financial advisor doesn’t have to be hard. SmartAsset’s free tool matches you with up to three financial advisors who serve your area, and you can interview your advisor matches at no cost to decide which one is right for you. If you’re ready to find an advisor who can help you achieve your financial goals, get started now.

  • When you consider selling an investment, be mindful of your potential tax liability. SmartAsset’s capital gains tax calculator can help you estimate how much you’ll owe in taxes based on how long you’ve owned the asset, as well as its initial and current value.

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