There are two types of accounts that you can use to purchase stocks: a cash account and a margin account. Knowing which one is best for your needs will help you make better investing decisions, so let's take a look at the differences between these accounts.
What Is a Margin Account?
A margin account is an investment account that you use to purchase securities. It is designed for people who want to buy more stocks than they can generally afford with cash alone, or those who plan on using borrowed money from the broker's lending program (called buying on margin).
For example, a broker may lend up to 50% of your initial deposit, which means if you put in $1,000 into your margin account, then the brokerage firm may loan you an additional $500 at their discretion.
A margin account carries some risk because it uses leverage and typically requires a minimum balance of around $2,000 to $3,000. Suppose this amount dips below what is required by regulation. In that case, there are penalties such as having trading privileges revoked or charged interest fees.
Additionally, losses incurred through margin investing are typically not tax-deductible. As a result, there can be a high risk of selling stocks at a loss.
What Is a Cash Account?
A cash account, on the other hand, is a brokerage account that doesn't use leverage. Of course, all of your investment money goes into the cash account, and you can only buy investments with it. Still, at least there are no interest charges or minimum balances to maintain.
You're also not able to borrow against margin in a cash account because these accounts don't have loans available for purchase. As a result, cash accounts may be best suited for investors who want simplicity and low levels of risk.
These types of accounts typically carry fewer fees than those offered by other firms, especially if they're managing assets below $100,000 (basically what's known as small-time banking).
The risks of using a cash account are that you have to pay taxes on any interest or capital gains growing in your account. Still, at least the cash is safe from any market downturns.
What Are the Differences Between the Two?
There are several main differences between a margin account and a cash account.
Margin accounts allow you to borrow money from the brokerage firm, which is known as "buying on margin" because of the extended loan.
Cash funds are not available for purchase in a margin account; however, they provide leverage with what could be borrowed at a higher interest rate than your credit card or bank would charge you.
The risks associated with using a margin account include increased volatility if prices move against your position plus any potential additional debt payments due when it's time to pay back these loans--not just when markets dip lower but also during periods of high growth.
Cash accounts offer simplicity and low levels of risk since there isn't borrowing involved (however, there is still risk in terms of the price volatility).
Which Should You Choose and When?
Whether you choose a margin account or a cash account is up to you and your overall financial goals. That being said, there are reasons most people will use one or the other.
When to Use a Margin Account
You should use a margin account if you're attempting to make a short-term trade that's expected to have high returns. This is because they allow for borrowing and are riskier than cash accounts, which don't involve borrowing but also come with less potential return (due to the lack of leveraging).
You should use a margin account if you're trying to maximize profits or minimize losses from any given position--especially during periods in which markets move quickly, volatility increases, and interest rates fluctuate more quickly.
Suppose your time horizon is relatively long (more than one year). In that case, it can be appropriate for you to invest more considerable sums of money into stocks using a margin account since there's an opportunity cost associated with tying up funds in such long term investments when those same funds could be used to earn more interest in a cash account.
When to Use a Cash Account
You should consider using a cash account when you want to keep your money liquid. However, you're not interested in leveraging the funds for a given period.
Suppose you have a long investment horizon (more than one year). In that case, it may be best if you don't use a margin account, but instead, invest more considerable sums of money into stocks using cash accounts since there's an opportunity cost associated with tying up investments over such long periods when those same funds could earn more interest in a cash account.
A cash account is designed to provide low-risk investment opportunities. In contrast, Margin Accounts are meant for higher risk/higher return trading strategies.
When considering which type of account will work better for you, consider how much capital and what kind of income stream you need, and timeframe expectations before investing.
Can I change a margin account to a cash account?
Yes, a margin account can be changed into a cash account, but it may cost you a fee to do so. Therefore, before changing your account type, make sure you have considered the actual costs and benefits of running a margin account.
Is Robinhood a cash or a margin account?
With Robinhood, you can trade stocks with both cash and on margin. However, to trade with a margin account on Robinhood, you'll need to be approved for the service.
What is the difference between a margin account and a cash account on Webull?
With Webull, the main difference between a margin account and a cash account is the risk. You could potentially lose more money with margin than your investment because it is a higher level of risk. Cash accounts are safer for most investors as they do not have the same risks as margin accounts may come with.
Now that you know the difference between a cash account and a margin account, it's time to decide which one is best for your needs.
Cash accounts are safer than they seem because there's no risk of defaulting on loans or getting in over your head, but if you want more investing flexibility, then opting for a margin account might be right for you.
The risks associated with these types of investments can't be ignored--make sure you understand what could happen before making any decisions!