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- Cash accounts are brokerage accounts funded by cash via bank account or check.
- With a margin account, investors can borrow money from lenders to purchase securities.
- You must have a margin account to trade options or futures contracts.
Cash accounts and margin accounts are both types of popular investment accounts for trading and market access. Although the two accounts offer similar trading functions — and are both offered by the best online brokerages — cash accounts and margin accounts vary when it comes to how they are funded, the level of risks involved, and trading strategies.
Here’s how cash and margin accounts compare.
Cash account vs margin account: The biggest differences
Simply put, cash accounts are funded by, well, cash and transactions must be paid in full. Margin accounts fund transactions by lending investors money from broker-dealers (otherwise known as investing borrowed money). This is referred to as making investments on margin.
“Monthly margin interest is added to the margin balance and will cause the margin to grow exponentially until the margin is paid down or off,” says Sandi Bragar CFP and chief client officer at Aspiriant Wealth Managemnt. “If the margin was used to buy an investment, the investor may be able to deduct some/all of the margin interest expense from their taxable income.”
Similar to a loan, the money you borrow from a broker has to be paid back. Margin accounts offer increased flexibility compared to cash accounts. However, there are substantial risks involved you should be aware of first before opening a margin account, such as the potential for greater losses, increased volatility, and forced sales.
Cash accounts are the better option for beginners, hands-off traders, and investors with low-risk tolerances. But folks with more stock market expertise and higher risk tolerance may find the chance of higher gains and the flexibility of investing on margin more appealing.
Keep in mind that most brokerages require you to have a margin account to buy options contracts or futures contracts.
How does a cash account work?
Cash accounts are a type of brokerage account that pulls from existing investor funds to buy and sell stock market securities like stocks and ETFs. The Federal Reserve Board‘s Regulation T oversees these accounts to ensure investors comply with regulations and have sufficient funds before purchasing securities.
You won’t be allowed to purchase securities if you lack adequate funding. Transactions through cash accounts must be paid in full by the settlement date, which typically is around two days after an order is placed. You can deposit funds into a cash account easily via check or by linking a bank account.
Cash accounts hold and buy securities such as stocks, bonds, ETFs, mutual funds, REITs, money market funds, and cryptocurrencies. Most cash accounts don’t offer options contracts.
Benefits of a cash account
Cash accounts are straightforward, beginner-friendly brokerage accounts suitable for all kinds of investors. The cash you deposit into your account is what you have available to purchase new securities. There’s no need to worry about lending amounts or accruing interest. What you see is what you get.
If you purchase a stock and its value falls, you can hold on to it to see if rises again in the long term. This is referred to as a buy-and-hold strategy, which is best for long-term growth. With a margin account, a broker may force the sale of a certain asset if its value drops significantly below the required equity amount. But with a cash account, you won’t be forced to sell at a loss.
Since cash accounts only allow you to spend money that you already have, there’s no concern that you will overspend on securities. You’ll know exactly what you are spending when an order is placed. If you don’t have sufficient funds, you won’t be able to buy that investment security.
In turn, there’s less chance of you incurring significant losses. Keep in mind that you should only invest money that you’re willing to lose. Even the least volatile assets, like fixed-income securities, have a level of risk attached.
Additional gains on uninvested cash
You may be able to earn additional gains on uninvested cash, also known as a cash sweep. How much you earn depends on the brokerage your account is held at and the offered interest rate. Vanguard, for example, is one of the best brokerages for uninvested cash and is currently offering a 5.30% yield.
Disadvantages of a cash account
You won’t get the same level of flexibility as you would with a brokerage account. You’re limited to the cash in your accounts. So if you want to buy a certain security that is out of your price range, you’ll either have to find another means of affording it or miss out altogether.
Can’t trade options
Cash accounts don’t typically permit investors to purchase options, but it depends on individual brokerages or investment apps. If you want to buy options or futures, you’re best off opening a margin account.
How to open a cash account
Opening a cash account through an online brokerage or firm is simple, as cash accounts are generally the default option. After you compare all your brokerage and investment app options, you can begin the sign-on process. You may have to give the following information:
- Legal name
- Employment status
- Risk tolerance
- Time horizon
- Social Security number
- Bank account information
- Legal ID (such as driver’s license or passport)
Minimums and fees vary from platform to platform. Make sure the brokerage you open your account through offers what you’re looking for before you sign up. For example, if you’re a socially conscious investor, make sure it offers an ESG portfolio or similar alternative.
How does a margin account work?
Margin accounts are brokerage accounts that offer margin trading options to investors. Just like a cash account, you can deposit money into your account to buy securities. But you can also buy securities with partially borrowed money from your broker. Securities purchased through margin don’t have to be paid in full by the settlement date.
You usually can only borrow up to 50% of the securities purchase price. The rest must be paid with available cash. For example, if you want to purchase a stock that is priced at $50 per share and you have $2,000 in your account, you can purchase up to 80 shares worth $4,000. You’ll owe $2,000.
You’ll essentially be acquiring a loan with margin lending. Depending on your brokerage’s policy, you’ll have to back the contents of your loan by a set time (including any accrued interest). You’ll have to pay back your margin loan even if your investment’s value plummets.
Benefits of a margin account
Potential for higher returns
You’ll likely be able to purchase more shares of certain securities with a margin account. If the security increases in value, you’ll receive even higher returns compared to if you had purchased half the amount of shares through a cash account.
Access to options and futures contracts
Options and futures contracts are generally only available to investors with margin trading enabled. Futures and options are a great way to diversify your investment portfolio, hedge against the market, mitigate risk, and earn additional gains. However, investing in options or futures is more complex than other asset options. Only experienced investors with knowledge of the market should buy futures or options contracts.
Equity as collateral
One of the biggest benefits of margin trading is the ability to put your security’s equity as collateral and capitalize on leverage. By buying more securities and increasing leverage, there’s a greater possibility of gains. If the collateral value increases, leverage opportunities also increase.
Disadvantages of a margin account
Potential for greater losses
In the same way that trading on margin amplifies your potential for higher gains, you’ll also be subject to potentially greater losses. And you’ll still be responsible for paying back the initial loan amount plus interest.
To open a margin account and access margin trading, brokerages often require much higher account minimums, as well as charge higher fees. For example, a standard self-directed brokerage account with TD Ameritrade doesn’t require an account minimum, but you’ll need to meet a $2,000 minimum to open a margin account.
Brokerages often require investors to maintain a certain level of equity. If an account falls below this amount, an investor may receive a margin call that demands additional capital or more securities to be bought so the total equity value of the account increases.
You have around five days to meet the minimum requirement. If not met, you may be charged a commission on the transaction or your broker may close any open positions without your approval.
“Margin calls can be particularly painful for investors who are forced to sell investments that have significantly declined in value to meet the net equity requirement for the brokerage account,” states Bragar.
Once you purchase a security with margin, you’ll have to maintain a certain level of equity referred to as “maintenance margin.” The SEC requires investors to have a minimum maintenance margin of 25% equity. Brokerages may be forced to sell any investments that drop below that minimum.
How to open a margin account
You can open a margin account with any online brokerage or investment platform that offers margin trading as an option. The process is nearly the same as opening a cash account but you’ll likely need to meet additional requirements, such as a higher account minimum.
Make sure to compare interest rates, minimums, fees, and more between different platforms before opening an account.
Cash account vs. margin account — Frequently asked questions (FAQs)
A cash account is better for beginners and passive investors looking for simple trading of securities like stocks, ETFs, bonds, and more. More advanced investors with higher risk tolerances may benefit from the potential greater returns and increased leverage from a margin account.
Robinhood offers both cash accounts and margin accounts. A cash account with Robinhood doesn’t require a minimum to start investing. There’s a $2,000 minimum requirement to open a margin account.
Margin accounts come with several risks and possible disadvantages that cash accounts don’t, such as the potential for greater losses, higher minimums, the potential of forced sales by brokers, and increased market volatility. Plus, you’ll pay interest on your margin loan amount.
What is share lending?
Some broker firms lend out shares held in cash accounts or margin accounts to short sellers or hedge funds in exchange for additional profit. This is called share lending. It’s important to note that firms can only lend out shares with the account holder’s permission.
Depending on the demand from short sellers and hedge funds, you may be able to rack up a significant additional profit on your assets. But make sure you understand the risks involved with share lending. You can request a quote from your brokerage or firm to see how much they will pay you.
Cash account vs. margin account: Which should you open?
Cash accounts and margin accounts are both types of brokerage accounts where investors can access the market and trade different assets like stocks, bonds, and index funds. Most investment accounts default as cash accounts, but experienced investors looking to trade options or futures contracts may consider opening a margin account.
Cash accounts are better for newer investors and hand-off traders looking to invest in securities with their existing money from a linked bank account. Trading is simple with cash accounts and suitable for long-term wealth-building strategies like the buy-and-hold strategy.
Bragar explains that beginners shouldn’t worry about margin off the bat. “Get used to your new account first. Experience what it’s like to buy and hold investments, monitor the account balances, and transfer money between the brokerage account and your checking account. Once you flex those muscles, consider adding the margin feature if and when there’s a need.”
Keep in mind that options contracts and futures contracts aren’t usually available with cash accounts. If that’s something you’re interested in, you’ll probably have to open a margin account.
Before opening a margin account, make sure you understand all the risks involved with trading on margin. You can always talk with a certified final advisor (CFP) or fiduciary advisor for professional guidance and advice.
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