The cash account is the most basic type of brokerage account. It allows you to buy and sell securities with money already deposited into your trading account.
How does a margin account work? With a margin (or Margin Account), you can borrow money from the broker to purchase securities. This borrowing uses either existing or new cash (or other securities) as collateral. According to the experts at SoFi Invest, “Margin accounts are generally considered to be more appropriate for experienced investors since trading on margin means taking on additional costs and risks.”
The cash account is excellent for new investors because there are no restrictions on how much you can buy and sell, while the margin account allows you to use leverage without purchasing additional shares of stock.
Difference Based on Investor Leverage
The amount of leverage you can use is one key difference between the cash and margin accounts. With a cash account, you can only trade with the funds already in your account. A margin account is an excellent option if you want to leverage and buy more shares than your account.
Let’s say that you have $25,000 in a brokerage cash account, and $20,000 of it has been used for other investments. If the stock price falls below 20 percent of its original value (down from 100), investors who own this stock in a margin account will be forced to sell their stock at a loss since they don’t have the funds to cover the margin call.
On the other hand, if you had $20,000 in your cash account and used it to buy shares of stock worth $25,000, you would only lose money if the stock price fell below $20,000 (the amount you invested). This is because you would cover the margin call with the cash in your account.
The downside of a margin account, then, is that you can lose more money if the stock price falls than if you had just bought the stocks outright. The upside is that you can make more money if the stock price rises.
Difference Based on the Interest Charged
The interest rate charged for a margin account is another key difference between the two types of accounts. The cash account has no associated fees, but the margin account has an interest charge based on how much you borrow from your broker. Most brokers use something called “maintenance” or “minimum” margin, which requires you to have at least 25% equity in your account.
For example, if you had a $20,000 cash balance and borrowed an additional $40,000 from the broker for trading purposes, you would be required to maintain at least 25 percent of the total amount ($60,000) in that margin account. Alternatively, you can pay interest on an amount below 25%. The interest rate you’re charged will depend on how much money is borrowed and what type of security it’s used to buy.
Most brokers charge between $100 – $200 per day for every $1000 worth of debt in your account, but rates can be as high as $400 – 600 per day. It’s important to remember that interest rates can change at any time, so it’s a good idea to check with your broker before opening a margin account.
In conclusion, the choice on whether to open a cash or margin account depends on the investor’s appetite for risk and desire to use leverage. The cash account is great for new investors, while the margin account offers more buying power with potential upside. Interest rates are another key consideration, and it’s important to understand how they work before opening an account.