To trade stocks, you need a brokerage account. When you’re deciding which type of account to open, you’ll need to choose between a margin account or a cash account. What’s the difference? And which is right for you? Read on to find out.
What is a margin account?
In a margin account, you can buy stocks and other securities on credit by borrowing part of the purchase price from your broker.
An outstanding loan comes with interest. You pay this interest when you sell or repay the security in your account.
Thus, with a margin account, you may be able to buy more securities than you could if you were limited to cash available in your account.
However, not everyone can open a margin account.
Typically, individual investors are limited to accounts with $2000 or $5000 minimum balances.
Corporations and trusts may be required to maintain higher minimum balances.
Your brokerage firm is responsible for assessing the margin account’s creditworthiness.
Suppose you fail to pay interest or return the borrowed funds. In that case, your brokerage firm can sell securities in your account to meet its claim. Still, it must give you at least five days’ notice before trading any stock wholesale would cause your account’s shares to fall below 50%.
What is a cash account?
In a cash account, securities must be paid in full at the time of purchase. There are no loans or margin transactions involved.
Typically, you can purchase only stocks and exchange-traded funds (ETFs) on margin. Mutual funds and other securities usually can’t be bought on margin.
In a cash account, you may hold as many positions as you want without having to borrow money from the brokerage firm.
However, you cannot lend out stocks held in a cash account to other interested parties, including short-sellers and hedge funds.
Suppose the value of your equity in a cash account falls below the required minimum. In that case, your broker must issue a “margin call” and demand that you make the necessary payment immediately.
For most investors with small portfolios, this is not feasible. If you don’t meet the margin requirement on time, your brokerage firm will sell some of your securities to pay off the margin debt.
It can be a severe problem if the market value of your stocks is falling quickly, and you don’t have cash in your account to make up for it.
Most brokerage firms place a limit on the amount of money borrowed from them against securities held in a cash account.
What’s the difference between a margin account vs cash account?
As you can see, a cash account is a more secure position because you cannot lend out the securities in your account to other parties without your permission.
A margin account allows investors to borrow money against the value of the securities in their account.
If you give the brokerage firm permission, they can also lend out shares held in a cash account to other interested parties, including short-sellers and hedge funds.
For a margin account, you may lend out the securities in this account to another party.
According to the experts at SoFi , “The accounts can be equated to a debit card vs. a credit card.” To learn more about margin account vs cash account, contact them today.