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When you first sign up to open an online brokerage account, you’ll be presented with two options: margin account vs cash account.
Though the account type is just the wrapper within which you will select your investments, the one you pick — margin account vs cash account — will make a big difference in your options as an investor.
Because one or the other will better suit your needs, you shouldn’t pick one at random. If you’re unfamiliar with how these account types work, you’re in the right place.
In this article, we’ll dive into a margin account vs cash account and, more importantly, how to determine which is best for you.
Margin Account vs Cash Account: The Main Difference
A margin account allows you to borrow from your broker; a cash account doesn’t.
If you have a margin account, you can make investments on margin. If you so elect, you don’t need to pay the full cost of the investment upfront, because you can get your broker to cover part of it for you.
Conversely, a cash account will require you to only make investments you can pay for upfront with money that is settled in your account.
Although this constitutes the primary difference between the two account types, don’t leave just yet: The difference may be straightforward but the implications are anything but.
Even for investors who never have and never will invest with borrowed funds, a margin account frequently comes in handy, which is why many (including myself) prefer them.
In order to make an informed decision on which is best for you, we need to dig deeper.
Margin Account Explained
As mentioned above, a margin account allows you to borrow funds from your brokerage to invest.
How does this work?
Think of a credit card: You buy things now with “borrowed” money and pay the lender back later.
Similarly, trading “on margin” means you purchased investments with borrowed money which you will pay back to your brokerage at a later date.
A typical margin agreement works like this: Say you want to buy $10,000 worth of stock ABC, but you only want to put up $5,000. You can take your $5,000 and borrow the other $5,000 from your broker. In total, you’ve got your $10,000.
Before going further, let’s note a few things:
- You will have to pay interest on money borrowed from your brokerage
- Trading on margin carries substantially more risk than a typical investment — it’s possible to lose more than your initial investment
- If the equity value in your portfolio drops below a required threshold, your brokerage can sell securities on your behalf — this is known as a margin call
Given the risks and costs involved, why would anyone want to use margin?
Higher returns.
For example, if you did buy $10,000 worth of ABC with only 50% of your money, a 10% increase in the stock price means a profit to you of $1,000, or 20% (minus interest).
Now, you pay back the $5,000 (plus some interest) to your brokerage and keep the rest. The use of leverage doubled your returns, even after returning the borrowed money.
But, if ABC fell by 10%, the opposite is true. You still owe your brokerage $5,000 plus interest, leaving you with less than $4,000. Leverage works both ways.
In addition to leverage, margin accounts give you:
- Purchasing flexibility
- Access to advanced options strategies, short selling, futures trading, and forex
Even if you don’t trade on margin, these no-cost bonus features are a huge draw for using a margin account.
Remember, just because you have a margin account doesn’t mean you have to trade on margin.
Like me, you can treat it like a cash account while utilizing the remaining features of a margin account which come in very handy.
More on how I do this below.
Cash Account Explained
As the name suggests, all trades done in cash accounts need to be done with available funds. If you want to buy a stock, you need to have the cash ready and waiting.
When you first open a brokerage account, you may have a few stocks in mind that you want to buy right away.
Unfortunately, if you want to use a cash account, you’ll have to wait.
You need to:
- connect your bank account, initiate a transfer
- wait 3-7 business days for the funds to hit your account
- maybe wait another day or two for the funds to settle
- then you can make your purchases
Similarly, when you sell a stock, you must:
- wait until the trade settles before the cash from that investment is available to you
- this will take 2-3 business days at most brokerages
- until the cash settles, you can’t use it to buy another stock
With a cash account, you will also be limited on the advanced trading you’ll have access to, such as some options strategies, short selling, futures trading, and forex.
However, these accounts are straightforward, safe, and easy to understand for new investors.
Margin Accounts vs Cash Accounts: Which is Right for You?
Hopefully, you’re beginning to identify which account type suits you.
The advantages of using a margin account are obvious, but they don’t come without risk. Cash accounts are much safer, but you miss out on flexibility.
So, which is right for you?
I can’t tell you which account you should use, but I can tell you what I’ve decided for myself.
Margin Account vs Cash Account: How (and Why) I Use a Margin Account
Remember, just because you have a margin account doesn’t mean you have to use that leverage when investing.
Like you, I had to make a decision: margin account vs cash account.
I have a margin account because it allows me to make investments while funds (from a recently sold investment or a new contribution) are settling.
Technically, I’m buying with margin, but the cash to cover the investment is there.
Therefore, I’m never really trading “on margin” — borrowing funds to magnify investment returns.
Most brokers will not charge interest for this use of margin.
By having a margin account but never actually trading on margin, I get the benefits of flexibility without taking on the risk inherent with the use of leverage.
For me, it’s the best of both worlds.
Using a margin account without ever touching margin loans is an incredibly popular choice among investors.
Margin Account vs Cash Account: FAQs
Next, we’ll take a look at the most commonly asked questions on the topic of margin account vs cash account.
Q. Can I change my margin account to a cash account?
Yes, almost all brokerages today allow you to switch back and forth between margin and cash accounts, though there may be a limit as to how many times you can switch.
Most frequently, if not given the choice when opening your account, your brokerage will default to giving you a margin account. If you want a cash account you may need to find how to change it from the start.
Q. Should beginner investors use a margin or a cash account?
Margin accounts are far more accessible than they used to be. As mentioned above, they’re now the default account type at most brokerages.
A brand new investor with no background knowledge of the features and risks of margin accounts may benefit from the safety of a cash account.
Remember, cash accounts are like debit cards and margin accounts are like credit cards. Both are fine, but one can put you in significantly more trouble if you’re not careful.
Once you get some experience under your belt, you may decide to switch to a margin account for its flexibility and other features.
Q. What is leverage? What are the risks of using it?
Leverage is the use of borrowed money to magnify potential returns. Leverage gives you the ability to control more shares than your own cash would otherwise allow.
Leverage magnifies returns in both directions. A 10% gain with leverage can become 20%. However, a 50% loss with leverage can send your portfolio to 0. With 50% margin, any loss greater than 50% will send your investment into the negatives.
For example, if you put $2,500 into an investment and borrowed another $2,500 and the investment drops 80%, that $5,000 is now worth $1,000.
You still owe your brokerage $2,500 plus interest — the entire $4,000 came out of your pocket, even though you only had $2,500 invested.
Q. What is a margin call?
Sure, a margin account gives you many more investing options and increased flexibility compared to a cash account, but it comes with risks.
Investing on margin, using leverage, will increase your profits or losses. When your losses grow too large, your brokerage may make a margin call to protect the account (and their money) from further losses.
Let’s say you purchased $10,000 of ABC with 50% your cash and 50% your brokerage’s. After buying a stock on margin, your brokerage will require a certain amount of “maintenance margin” in your account at all times, usually 25%.
For our scenario, you would need $2,500 in your account to avoid a margin call.
If the value of the investment falls to $7,000, you still owe the brokerage $5,000, leaving you with $2,000 in equity.
Now, the brokerage can make you move $500 of cash into your account to meet the minimum or sell securities on your behalf to make up the difference.
The Bottom Line: Margin Account vs Cash Account
For most investors (myself included), the better option of the two is a margin account, assuming you’re responsible with margin loan features.
The biggest advantage of a margin account over a cash account is flexibility. If I’m waiting for cash from a previous trade to settle, or waiting on a cash transfer to hit my account, I don’t want to wait.
With a margin account, I don’t have to. I also have advanced options for trading at my disposal. If you decide to trade on margin, understand the risk you’re undertaking.
As is the case with all forms of debt, investors with margin accounts need to be careful with how much leverage we deploy. Personally, I’ve never made an investment I didn’t have the cash for and never will.
Assuming you don’t risk too much, a margin account is a valuable tool.
That said, if you’ve struggled in the past with debt (overspending on a credit card, for example), a cash account may be the safest option to protect you from yourself. Like a debit card, you can’t buy without having the cash needed available.
Weigh the pros and cons of each, then decide if a margin account or a cash account is right for you.
