For most new investors, a standard cash account is probably the best option. But as you gain more experience, a margin account may be the better choice.
A standard cash account allows you to buy and sell securities with money from your bank account without borrowing any money from your broker.
The main advantage of a cash account is that it lets you make purchases for free. Most brokers charge about $6 -$10 per trade, which means that if you were to buy 10 different stocks in a single month, those commissions would eat into a big part of your profits.
You can avoid this by purchasing mutual funds instead of individual stocks. Funds come with their own set of fees and expenses. If an investor is primarily purchasing mutual funds and ETFs, they likely do not need a margin account.
A margin account gives you the opportunity to buy more securities than you could with a cash account by borrowing money from your broker.
The main advantage of a margin account is that it offers lower interest rates on the borrowed money than you would pay on a credit card or personal loan. For example, the average interest rate on a margin account is currently 6.24%, while the average interest rate on a credit card is around 17%.
However, margin accounts come with more risk than cash accounts. You may have to sell some of your holdings to cover the cost of your loan if the market drops and your investments can lose value. Your broker can even sell some of your shares without consulting you if you don’t meet a margin call.
In order to withdraw money from a margin account for personal purposes like paying off debt or buying a house, a cash account might be a better choice, since you will have to repay any withdrawals.
What is a cash account and what are the benefits of using one?
A cash account is an account with a brokerage in which you can only buy and sell securities for the cash that you have on deposit. The benefits of using a cash account include:
-No requirement to maintain a minimum balance.
-There are no commissions on stock or ETF purchases.
-The margin interest rate does not exist.
What is a margin account and what are the benefits of using one?
A margin account is an account with a brokerage in which you can borrow money from the broker to purchase securities. The benefits of using a margin account include:
-You can purchase more securities than you could with a cash account because you’re borrowing the money to invest.
-It is possible to charge a lower interest rate on funds.
-You have more access to your cash because you don’t have to keep as much on deposit at all times.
What are the risks of using each account?
Risks of using a cash account
You won’t be able to gain or lose money in the cash account.
Cash accounts incur fees if minimum balance requirements aren’t met; however, these fees are usually low and sometimes waived altogether depending on how long you’ve had an account with them and what type of investor (retirement, etc.) you qualify as based on their policies.
Overall this risk can be minimized by depositing more money into the account to generate returns.
Risks of using a margin account include
When the value of the securities you’ve bought declines and you are forced to sell them, you may lose more money than you deposited in your account.
In some cases, you may be charged a higher interest rate than the margin interest rate.
You could be called upon to deposit more money into your account (known as a “margin call”) if the value of your securities falls below a certain level set by your brokerage. If you do not meet this request, your broker has the right to sell some or all of your securities without consulting first.
Which account should you use? The importance of choosing the right type of account for your financial goals
It’s up to each individual investor to decide which types of accounts they will open. Choosing the type of account to open is up to each investor. If an investor is buying individual stocks, it is better to open a cash account first to learn about investing, gain confidence before buying on margin, and minimize their risks.
As the size of an investor’s portfolio increases, he or she may want to consider switching from margin to cash accounts to reduce the risk of losing more than they deposit.
Overall you should weigh your current situation against these two options before deciding on one or both accounts for yourself. Good luck!
Cash Accounts allow purchases for free (or very low fees) and have no minimum balance requirement or commission on stock or ETF purchases.
Margin Accounts allow investors to purchase more securities than they could with a Cash Account and may have lower margin interest rates.
The risks associated with Cash Accounts are that the deposited money is not invested and if minimum balance requirements are not met, fees may apply.
Margin Account risks include losing more money and paying a higher rate of interest than the margin rate on funds. If you do not meet a margin call, your broker has the right to sell some or all of your securities without consulting you.
Which account an investor should use depends on their personal situation and investment goals. For example, those who are purchasing individual stocks may want to start with a Cash Account to minimize their risks.
More experienced investors who are looking to purchase more securities may want to open a Margin Account. Investors should weigh their current situation against these two options before deciding on one or both accounts. Good luck!
While both accounts let you buy and sell securities, they do so under very different circumstances. While somebody may want to open both types of accounts at one time. It’s also common for investors to choose one type and stick with it until certain events transpire that require them to convert their current account into the other option.
For example, somebody who starts out using a standard cash account might open a margin account if they start to experience losses in their portfolio that they need to cover.