Your trading account has a HUGE impact on your returns

Choosing a trading account is another important decision you must make when creating an investing process.

Believe it or not, this decision has a direct impact on on your bottom line.

True Story

Years ago, I started experimenting with options; particularly covered calls.

More recently, I created a safe investing process for myself, and executed that strategy with a discount broker.

The strategy proved to be successful (I made money), so I decided to improve my process by looking for ways to reduce costs.

My strategy required monthly trades, so I knew that finding a broker with low commissions and fees would be a good place to start.

For fun (I know, I have no life) I used my trading log and updated it with different commission structures just to see how much money I could have saved.

Same trades, just a different cost for each trade.

With broker #1, I rang up a total commission bill of $1500 give or take a few cents. Like I said...I did a lot of trading.

With broker #2, my commission bill would have been $690. For the same trades...with the same ETFs.

Safe Investing Principle #7 in action...I paid a broker an extra $810 dollars that could have gone in my pocket.

Now that you have a real-world example under your belt, know that there are times when this decision will be made for you, such as your employer-sponsored retirement accounts or if you pay someone to manage your money.

Whether you decide or not, the type of trading account you use impacts your ability to apply certain investing techniques and strategies, the types of investments you can buy and sell, and as I experienced, even how much money you can make!

Personal Accounts

A personal investment or trading account is one that you use for your daily personal finance needs.

For example, a bank account can be considered one type of personal investment account. It acts like a warehouse for your money, and since investing is about having access to money sometime in the future, bank accounts qualify.

As your accounts grow, make sure the balances are still within the maximum covered by the FDIC and SIPC. This is especially important if you have more than one account with a single bank or broker.

For more information of these limits and other considerations on account sizing, check out my page on portfolio sizing.

Bank Accounts (Savings, Checking, Money Market, etc.)

Advantages

Most are insured by the FDIC
You have easy access to your money (high "liquidity")
Risk of loss is very low
Inflation risk is high (losing purchasing power)

Disadvantages

Rates of return (i.e. interest rates) are usually low

Retail Accounts (Investing / Trading)

Advantages

Provides access to markets
You have easy access to money that isn't invested ("liquidity")
Risk of loss can be high or low
Inflation risk can be high or low (losing purchasing power)

Disadvantages

Rates of return are not guaranteed
Managing risk is up to you

Professional Trading Accounts

These accounts are the ones that we all want, but can't afford. Professional accounts are reserved for accredited investors and include hedge funds, institutional accounts, and managed futures accounts.

Advantages

Provides access to specialized investment instruments
Rates of return can be extremely high

Disadvantages

Rates of return are highly volatile
Access to your money is not easy (low "liquidity")
Managing risk is up to someone else

Retirement Accounts

Most investment brokers offer the ability to set-up a retirement account. You can now take advantage of a low cost broker, and reduce the level of commissions and fees you pay.

And you can also keep things simple by having all your investing accounts in one place (if that is important to you).

Defined Benefit Plans

This plan type is more commonly known as a pension plan. Basically, an employer promises to pay you a predefined monthly benefit after you retire. The amount of the payment is determined based on your salary, years of service, and age.

It is an EMPLOYER'S responsibility to manage investments in order to pay out the monthly benefit upon retirement.

Defined Contribution Plans

This type of plan is more prevalent in today's workforce. Instead of guaranteeing a future, monthly benefit after you retire, an employer provides a defined contribution into an employee's retirement account while they are employed.

The deposited amount varies, based on the employer's compensation structure, an employees personal contribution, and whether or not that contribution is matched.

It is an EMPLOYEE'S responsibility to manage investments in order to create a monthly benefit upon retirement.

Individual Retirement Accounts (IRA)