Bank vs. Brokerage: Choosing a Portfolio Custodian that’s Right for You

This article will primarily cover the basics of the nuanced distinction between a bank and brokerage custodian, and will provide you with the foundational knowledge you’ll need for an informed conversation with your financial advisor.

What’s the difference between a bank and a brokerage?

As an extreme oversimplification, a bank is an administrator that holds and manages your funds on your behalf, while a brokerage is a company that facilitates the exchange of assets and services between two parties.

To flesh out the differences a little more, the primary purpose of a bank is to provide administrative and consultative support to institutional investors.

These services are usually paid for with a percentage of the assets under management (AUM), averaging between 0.2% and 2% per year, and often include custodial services such as asset safekeeping, trade settlement, income collection, corporate action monitoring, automated sweep investment and comprehensive reporting.

Bank custodians have a fiduciary duty to act in the best interests of their clients, and often take on an advisory role in helping institutional investors manage their finances and meet their goals.

Meanwhile, the primary purpose of a brokerage is to facilitate transactions that involve securities (stocks, bonds, etc.) and other assets between an investor and a financial institution.

Full-service brokerage firms will support this central goal by providing services such as market analysis, tax services and advice, estate planning, insurance and other services in addition to their primary role as a broker. Meanwhile, discount brokers and robo-advisors will often only provide the normal brokerage service of facilitating trades without the personalization found at full-service firms.

In addition to the percentage fees charged by banks, brokerages may also adopt a variety of other payment options, such as charging per executed trade, charging for services à la carte or not charging a fee at all, but instead only offering proprietary trading options (usually when acting as a sales arm of a larger financial institution).

Is there a difference between a bank custodian and a brokerage custodian?

While they may seem similar at face value, there is one major difference between bank and brokerage custodian accounts.

Specifically, assets held in a bank custodial account are held on behalf of the institution or individual and are not counted on the bank’s balance sheet. This means that these funds are not subject to claims from the bank’s creditors should the bank fail, and can be further protected by the Federal Deposit Insurance Corporation (FDIC) if the account carries the underlying bank FDIC coverage, which could facilitate the return of cash deposits up to $250,000 per ownership category.

Meanwhile, assets held by a broker are often commingled together for the purposes of acting as collateral for various financial strategies or covering short positions.

For example, when you buy or sell securities with a broker (or even hold funds in one of their accounts), those investments are registered in the name of the broker with all ownership rights assigned to you as the beneficial owner.

While this is done for a variety of reasons, the most relevant outcome is that these assets are often included on the brokerage’s balance sheet, meaning they may be subject to distribution to the brokerage’s creditors should the institution fail.

While clients with accounts in the United States can work with the Securities Investor Protection Corporation (SIPC) to recover a portion of their investments of up to $500,000 in securities and $250,000 in cash, this can be a lengthy process that could end in the return of a reduced distribution of their investments.

For these reasons, institutional investors should look for custodians who offer both FIDC and SIPC coverage depending on whether the money is stored in cash accounts or investments, regardless of whether that’s with a bank or a brokerage.

Additionally, you should take the time to understand the distinction between how your funds are held and invested and the potential outcomes of each possible scenario.

What are some other pros and cons of choosing one custodian over the other?

There are several less prominent differences you should also consider when weighing one option against the other:

• Fees and expenses — Bank custodians generally charge a small fee based on the assets under management. Brokerages instead leverage a wider variety of billing structures, ranging from the normal AUM percentages fees (paid once per year) to fees paid for each transaction.
• Access to additional services — While both options will act as custodians for your assets, banks will generally offer more in-depth advisory and reporting services, while broker-dealers may focus on offering market research and trade recommendations. In other words, there is usually significant overlap in the services offered by each option, though each custodian’s focus and fiduciary requirements may differ in nuanced ways.
• Target audience and risk profile — Investment banks are often the preferred choice of more risk-averse clients and institutional investors, while brokerages may be more appealing to investors who are willing to take on more risk for potentially higher returns.

Choosing the custodial strategy that’s right for you

To summarize, the primary difference between a bank custodian and a brokerage custodian lies in how your assets are allocated on paper.

For banks, you retain full legal ownership of the funds and pay a small fee to your portfolio manager for custody services such as regular advisory meetings and financial guidance, asset safekeeping, trade settlement and comprehensive reporting.

For brokerages, you add your funds to a pool of resources managed by the firm’s financial experts, who will then use the funds to purchase various securities and other assets as a means of accelerating growth. These funds will belong to the brokerage on paper, with you as the beneficial owner, making it harder to recover your funds should something go wrong. This inherent risk is the tradeoff for access to the brokerage’s services and strategies for generating passive income.

Both options have pros and cons you should consider before determining where to invest your funds. For this reason, it’s strongly recommended that you speak with an experienced financial advisor who can guide you to the investment options that will work best for your situation.

To learn more about the different options you have available for choosing where to store your assets, and to explore the different solutions Associated Bank has available for helping you manage your funds, please reach out to us online to find a wealth management team near you.