Cash Account vs. Margin Account: Key Differences
The two main types of brokerage accounts available with almost any online broker are cash accounts and margin accounts. Although both enable you to buy and sell investments, the latter has slightly more advanced features and allows investors to borrow capital.
Of course, the added level of complexity and the looming risk associated with any line of credit can be too overwhelming for some consumers.
That’s why it’s important to weigh the pros and cons and choose the appropriate type of brokerage account based on your individual preferences and needs.
The following guide will help you understand the difference between margin and cash accounts so that you can make the most profitable choice.
What Is a Cash Account?
If you’re on the hunt for a brokerage account with straightforward functions, a cash account is your best bet. This option allows you to conduct transactions only with the money that’s already in your account.
In other words, you can’t lose money you don’t have.
Perhaps more importantly, these accounts serve as great alternatives to both savings and checking accounts. Your money is stored away safely while it earns high-yield interest, and you can make deposits and withdrawals as needed.
In short, you can make investments and still access your cash.
An online brokerage may suggest investing towards a money market fund, whereby you can attain small returns with limited risk.
But unlike a regular checking account, the overall aim of a cash account is to inject your money into the stock market. You won’t necessarily be able to purchase all the securities you have in mind, but the list of options is pretty extensive:
- Exchange-traded funds
- Publicly traded real estate investment funds (REITs)
- Mutual funds
- Index funds
A more advanced investor may require a more extensive list to diversify and expand their portfolio. Nevertheless, cash accounts have their share of advantages.
- Low risk: There is much less risk with a cash account because the amount that you can lose is capped. For instance, if you deposit $1,000, you can only use and lose $1,000.
- Accessibility: With a cash account, you have instant access to your money.
- A reduced ability to diversify your portfolio: If you want more diverse profiles in the stock market, a cash account will limit you.
What’s a Margin Account?
A margin account is a lot like a credit card simply because it enables you to purchase investments on credit.
In addition to the money you already have, you’ll be able to secure loans to augment investment opportunities.
Key margin privileges include more investment options that enhance your portfolio. However, there are more risks involved. If the investments you purchase lose value, your losses will be substantially greater.
For starters, you’ll still have to repay the loan that you got through the brokerage while making up for the money you lost on a particular stock.
Such a loss can be avoided with cash accounts because you can wait for the stock to simply rebound.
With a margin account, you’ll be charged interest for your loans. Therefore, it can take longer to break even and make a profit.
For example, if your loan has a 5% APR, then you will need to increase your investments by at least 5% to break even. To actually make a profit, you’ll need a substantially greater investment.
On the plus side, there is a great deal of flexibility when it comes to repaying loans as there is typically no set repayment schedule. Of course, the longer you take, the higher the interest charges.
Unlike a cash account, a margin account has a few requirements, which might vary depending on the brokerage.
These requirements are generally outlined by federal agencies such as the US Securities and Exchange Commission and self-regulatory organizations like the Financial Industry Regulatory Authority.
But individual brokerage organizations may also have their own set of requirements. Here are some examples:
- Minimum margin: A minimum margin account requires a minimum cash deposit. For instance, FINRA requires a minimum cash deposit of $2,000 or 100% of the purchase price for your chosen investment.
- Initial margin: During your initial margin purchases, the amount you can borrow will likely be limited to 50% of the cost of the securities you wish to purchase.
- Maintenance margin: For a maintenance margin, you’ll need to be able to maintain a certain margin balance in your account. If your account drops below the maintenance margin, then you may attain a margin call.
A margin call is simply when your brokerage requires you to increase the value of your margin account. This can either be done by adding more cash or liquidating some of your existing assets.
- Potential to increase gains: There is more potential to enhance your gains with a margin account because you can borrow money to increase your investments.
- More securities: There are more securities that you can invest in with a margin account.
- Great for short-term cash flows: Seeing as there are no additional fees to maintain a margin account, it can be great for short-term cash flows.
- Much riskier: Margin accounts are much riskier than cash accounts because you can lose your own money as well as the money you borrowed.
- Interest payments: Money borrowed from a brokerage comes with interest.
Comparing the Accounts
The main difference between a margin and a cash account is that the latter allows transactions with available funds while the former lets you borrow money.
All the securities you purchase using this account act as collateral for your loan.
Seeing as there is less risk of losing lots of money with a cash account, it’s the better option for investors who want to play it safe.
Likewise, a cash account can offer the investor more financial stability as the securities are generally much safer. On the other hand, there are more securities to invest in with a margin account.
However, these are more susceptible to fluctuations, and the return on investment is anything but guaranteed.
They both make financing easier and investments less intimidating. But a margin account can lead to bigger losses and more fees due to interest payments.
New investors typically prefer a cash account, whereas more experienced investors are perfectly comfortable with margin accounts.
Margin accounts are great for those looking for high profits in short-term investments. Although they come with more risk, they can make you more money if you invest wisely.
Which Is the Best Option for You?
If you still can’t decide whether a cash or margin account is best for you, here are some of the things you should consider:
- Prefer to play it safe? Opt in for a cash account because it doesn’t require any collateral. You’ll never lose more than you deposit.
- Want to expand your portfolio? If you want to increase and expand your portfolio, there are many more options with a margin account as these grant you access to more securities.
- Want to be able to deposit whatever you want? Then you might want to consider a cash account as some margin accounts require a minimum cash deposit, like those in association with FINRA.
- Need to borrow money? If you need to borrow money for your investments, a margin account offers you that ability.
Answering these questions based on your financial needs and preferences should help you make up your mind. There is a lot of information to consider and absorb when evaluating the differences and similarities between the accounts.
Hence, it’s best to decide whether you need to borrow money or you are happy to invest your own.
Ultimately, deciding which type of brokerage account is best for you depends on the level of risk you’re willing to tolerate and your knowledge about different trading strategies.
Some of the more experienced investors who have mastered speculative trading will be able to profit from a margin account by selling stocks short.
And while there is more risk involved, there is also more flexibility if you don’t panic about unexpected price swings.
For those who prefer more basic investments, then buying and selling with a cash account is the better option. It offers more financial security and can help you step into the world of investments in a much safer way.
Which is better, a margin or cash account?
Deciding which account is better depends on your level of expertise and financial preferences. Experienced investors who want to sell stocks short and can handle the potential risks can also handle a margin account.
These offer higher returns and allow you to borrow money to purchase securities that serve as collateral. If you prefer to limit your losses to the amount of money you already have, then a cash account is the better option.
Is margin the same as a cash account?
A margin account is not the same as a cash account. Both make financing and investing easier, but margin accounts offer different features.
The main differences between the two relate to the level of risk. With cash accounts you can only make purchases with the money you have, whereas a margin account magnifies your losses and increases potential return by allowing you to borrow money.
Is a margin account a good idea?
A margin account is a good idea for people who know what they are doing and who are knowledgeable about the securities they’re buying. They have the potential for better returns and a greater downside risk.
A brokerage firm can help you expand your portfolio with a margin account as they can loan you money. If you want to play it safe and/or cannot afford to incur financial losses, then a margin account is not a good idea.
Can I use a margin account as a cash account?
A margin account and a cash account are two separate types of brokerage accounts. Therefore, they cannot be used in combination with one another.
Both require monetary deposits from the cash holder, yet a margin account can also be used to secure loans from a brokerage. A margin account offers more features and securities than a cash account.
Albert Einstein is said to have identified compound interest as mankind’s greatest invention. That story’s probably apocryphal, but it conveys a deep truth about the power of fiscal policy to change the world along with our daily lives. Civilization became possible only when Sumerians of the Bronze Age invented money. Today, economic issues influence every aspect of daily life. My job at Fortunly is an opportunity to analyze government policies and banking practices, sharing the results of my research in articles that can help you make better, smarter decisions for yourself and your family.
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