What makes a cash account different from a margin account?
A cash account allows you to buy stocks and bonds using the money you have on hand, but a margin account allows you to borrow money from your brokerage to buy more assets than you could with cash alone. The most significant distinction is that with margin accounts, you may borrow money to possibly increase your profits, but you’ll also be taking on far more negative risk. It’s possible to lose more than your original investment with margin accounts.
What are Cash Accounts?
When you think of a Brokerage Account, you generally think of cash accounts, and they’re very simple. You may fund your brokerage account by transferring funds straight from your bank account, but you can also mail a check.
You’ll probably have a few alternatives after the money is with your brokerage: Some brokerages keep cash in a money market fund, which has low returns but low risk and allows you to access your money whenever you need it. It’s similar to a savings account in that it allows you to access cash when you need it, but it pays higher interest than a checking account.
What about a margin account?
If a cash brokerage account is like a debit card, letting you buy securities with only the amount of money you already have, then a margin account is like a credit card — you can buy securities with borrowed money, and pay the lender back later.
Make no mistake, trading “on margin” is an advanced trading strategy. While new, easy-to-use investment apps have lowered the mystique around margin accounts and made them far more accessible than they used to be, that doesn’t mean they’re appropriate for inexperienced investors. And if you’d rather put in place a hands-off, Long-Term Investing Strategy, margin accounts probably aren’t for you.
Margin trading has a much higher level of risk than cash accounts. It’s possible to lose more money than you put in. On money borrowed from your brokerage, you’ll have to pay interest.
If you don’t have enough equity in your margin account at any moment, your brokerage can sell your securities without alerting you (more on this below).
Pros and Cons?
The capacity to manage more shares than you could with your own money through leverage in investing opens up new possibilities for your investment’s performance that would otherwise be considerably more difficult, if not impossible, to achieve — much like shifting that rock.
With a cash brokerage account, you’ll be exposed to the same risks associated with purchasing any investment. If you invest $5,000 in stock and the price drops 20%, your investment will lose $1,000 in value.
Your losses, like your earnings, are multiplied when you trade on margin. So, if you have $5,000 to invest and borrow $5,000 to purchase $10,000 in stock, and the Stock Price drops 20%, the stock will lose $2,000 in value.
Yes, margin accounts offer a bigger potential for profits than cash accounts, but they also have a far higher chance of losing money. Even a generally solid investment might be shattered by big price fluctuations that come out of nowhere. And if you’re utilising leverage at the same time, it’s a recipe for disaster.
What is a margin call?
When your brokerage issues a margin call, you must either deposit cash or liquidate part of your assets to boost the value of your account. Margin calls happen when you don’t have enough money in your margin account to fulfil the maintenance margin, which might happen as a result of withdrawals or a drop in the value of your investments.
What should you choose?
Most simple investors will be satisfied with a cash account. There’s little need to engage in margin trading if you’re a new investor.
To sell stocks short, commonly known as short selling, you’ll need a margin account. You earn from a stock’s price drop using this speculative trading approach. Short selling, like purchasing on margin, is a complicated Technique for Expert Investors.
A margin account, on the other hand, can provide flexibility that is useful in a situation. Trading on leverage is dangerous and should only be done by experienced investors, but having a margin account for short-term liquidity flexibility can provide you with the best of both worlds.