Are Online Brokerage Accounts Safe?

Are online brokerage companies safe in 2019? How secure and reliable are stock broker and IRA accounts?

Overview of the Safety of Online Brokerage Accounts

If you’re interested in opening an investment account, you probably have questions about the security of this type of financial management. This article will look at the protections that are in place for online brokerage accounts, and compare these safeguards to those available at America’s banks.

Legitimacy of Online Brokerage Firms

Rest assured that the vast majority of online discount brokers are perfectly legitimate. In fact, some of them are owned by large American banks. Merrill Edge, for instance, is owned by Bank of America, one of the largest financial institutions in the world. Other broker-dealers that aren’t owned by banks have been in the brokerage business for decades. Fidelity, for example, started in 1946.

Insurance for Brokerage Accounts

The Federal Deposit Insurance Corporation, better known as the FDIC, protects American banks. It does not provide any insurance for brokerage accounts. The investment world is considered a separate industry, which means it is both regulated and protected by different organizations.

The Securities Investor Protection Corporation is a Congressionally-mandated organization that is funded by member brokerage firms. It insures securities (stocks, bonds, ETF’s, options, and mutual funds) up to $500,000, which is actually twice the protection that the typical FDIC-insured bank account receives. Under SIPC policy, up to half of the $500,000 insurance can be used for free cash balances.

There’s an important difference between SIPC and the FDIC. The banking unit protects the amount you deposit, while the brokerage unit protects the number of shares in a trading account.

As an example, say you deposit $500 in a checking account that is FDIC insured. If the bank declares bankruptcy, that $500 is guaranteed. The U.S. government will write you a check for that amount if the bank can’t.

Instead of depositing the $500 in a bank account, let’s say you put the $500 in a brokerage account. You then buy five shares of a stock that cost $100 each. SIPC guarantees those five shares in case the broker-dealer goes out of business. SIPC does not guarantee the market price. If the stock goes to $0, your account is worth $0 even with SIPC protection.

Thus, we arrive at a very important difference (perhaps the most important difference) between the banking industry and the investment world. Investments can fluctuate in value, whereas bank deposits have a fixed value. So securities accounts will also carry more risk than deposit accounts.

Safest Online Brokers

TD Ameritrade and Ally Invest have never taken a bailout and are reliable companies to open regular brokerage or IRA account.

Safety of Technology

All online brokers by their very nature offer trading tools for their self-directed customers. These range from simple websites to more advanced websites to mobile apps to smartwatch platforms. Some brokers provide desktop platforms that vary in complexity.

Online brokers have the same obligation to protect your data that other companies have. When you submit your information over the Internet, it will be sent over an encrypted network. You can verify that your connection to the broker’s website is secure and encrypted by clicking on the padlock next to the website address (URL).

Brokerage houses do take precautions to safeguard your personal information, but they have been hacked before. For example, TD Ameritrade’s servers were breached by cyber criminals in 2007, and the Social Security numbers of many of its customers were stolen. Such incidents don’t make online brokerage firms more risky than other financial organizations, however. Hackers have broken into other computer systems as well. The recent data breach at Equifax is one example.

Some Securities Are Riskier than Others

If you’re just starting out in the brokerage world and you’re concerned about the safety of your investments, you can begin with securities that have a higher degree of protection than others. For example, large-cap stocks with a long history of dividend payments are generally safer than small-cap stocks that have no history of payments. Blue chip stocks are generally safer than new stocks that have not been proven yet.

Funds (mutual funds and ETF’s) are generally safer than stocks because they are a basket of stocks and bonds. By diversifying across many different assets, the funds have less risk of going down substantially (and less hope of going up substantially).

Bonds are generally safer than stocks because bonds have a fixed face value. Thus, the prices of bonds tend to be more stable than the prices of equities.

Not all bonds are created equal, however. Some bonds are highly rated (AAA grade), while other bonds will be below investment grade. These are the so-called junk bonds, rated below BB+. Short-term bonds are generally safer than long-term bonds.

Instead of investing in individual bonds, you can trade bond funds. These come in all shapes and sizes, based on the underlying debt in the portfolio. The safest funds are composed of highly-rated, short-term bonds.

All of these products and more can be bought and sold at America’s online broker-dealers. To stay safe, you just need to know what to invest in.

Managed Accounts

If you’re still not comfortable deciding what to buy, you can hire a professional to make trading decisions for you. Many online discount brokers do offer this service. The people who manage brokerage accounts should be licensed investment professionals, but it doesn’t hurt to verify before making a commitment.

Because discount brokers emphasize low fees, several have developed automated software programs that make all trading decisions. These so-called robo-advisory services can cost as little as 0.30% per year of account value, or even less in some cases. Because the robo-trading system is new, however, there perhaps hasn’t been enough time to vouch for the technology’s reliability.