Cash Account vs. Margin Account: What’s the Difference?
July 16, 2021
Choosing between a cash account and a margin account may depend on your risk tolerance and trading style.
When you sign up for a new brokerage account, your broker will ask if you want to open a cash or margin account. There are several differences between the two — in particular, margin accounts involve borrowing money to invest.
Deciding between a cash account vs. a margin account is an important decision. Read on to discover which account option makes the most sense for you and your trading style.
At a Glance: Cash Account vs. Margin Account
|Cash Account||Margin Account|
|Best For||Novice, risk-averse, retirement, or long-term investors||Experienced investors who want to try short-selling and other advanced options|
|Funding Your Trades||You deposit cash||You deposit cash and can borrow money to trade|
|Risk Level||More conservative||Carries greater risk|
|Minimum Deposit||Varies per brokerage||$2,000 or 100% of securities purchase price (may be higher)|
|Allowed Trades||Stocks, bonds, funds, real estate investment trusts (REITs), cryptocurrencies, some options trades||All cash account trades, plus short selling, advanced option trades, forex, futures, etc.|
What Is a Cash Account?
Cash accounts are the most common type of brokerage account. You can use one to trade the most straightforward investments — stocks, bonds, exchange-traded funds (ETFs), etc. Some brokerages will also allow you to use your cash account to make some basic options trades.
Funding a cash account is also pretty straightforward. Typically, you’ll just transfer money directly from your bank or pay by check, either mailed in or deposited through your brokerage’s mobile app.
When you purchase a security with a cash account, you’re limited to the money in your account. So, for example, if you’d like to buy $5,000 worth of stock but have only $2,500 in your account, you’d have to either add $2,500 from your bank or sell $2,500 worth of investments in your portfolio to make up the difference.
When it comes to risk, because you’re limited to how much money you can invest — and lose — cash accounts are more conservative and are best for novice investors.
What Is a Margin Account?
Using a margin account is like placing trades with a credit card. You can purchase securities with money that you borrow from the brokerage and pay it back later.
Most margin accounts let you borrow up to 50% of the purchase price of a security. This gives you more buying power.
Let’s go back to that example of the $5,000 worth of stock you’d like to buy. If you have a margin account with only $2,500 cash available, you could borrow $2,500 from the brokerage and buy the shares worth $5,000.
Of course, you’ll owe interest on the amount you’ve borrowed. So you’re betting your trade will increase in value to cover both the interest and the amount borrowed. You get to keep all the rest.
If the trade doesn’t increase in value, you’ll still owe the interest and borrowed money. Unlike cash account trades, you could lose more than your initial investment.
That risk makes margin accounts a good choice only for experienced traders who can stomach some risk.
What Are Other Differences Between Cash and Margin Accounts?
Besides the whole borrowing money thing, there are some other significant differences between cash and margin accounts.
Because margin accounts involve debt (the money you owe to the lender/brokerage), they’re inherently riskier than cash accounts.
With a cash account, the money you can lose is limited to the amount of money you put into a trade (your principal).
With a margin account, on the other hand, you not only can lose your principal, but you’re also on the hook for the borrowed amount plus the interest.
The amount of money you must deposit to open and maintain a cash account varies per brokerage. Some trading apps, such as Robinhood and Webull, require no minimum deposit be made to your cash account.
On the other hand, when you open a margin account, by law, you must make an initial minimum deposit before placing a trade.
The U.S. Financial Industry Regulatory Authority (FINRA) requires all margin account holders to deposit either $2,000 or 100% of the purchase price of the margin securities (whichever is higher). Some brokerages might require even greater deposits, so make sure to find out before opening an account.
FINRA also mandates that brokerages require a certain amount of equity in your account at all times. This is called the maintenance margin requirement.
According to law, you must maintain 25% of the total market value of your margin account securities in equity. However, many brokerages set minimums higher than this.
If you don’t have the required amount, the brokerage can make you deposit more cash in your margin account (called a margin call). Or the brokerage could go ahead and sell holdings from your portfolio to make up the difference without informing you.
If you’re looking for a wide variety of trading strategies, margin accounts are the way to go.
With a cash account, you can’t use many strategies beyond buying and selling stocks, bonds, ETFs, etc. For example, you can’t use a cash account to short a stock.
Cash accounts do allow you to harness more complex strategies such as writing calls and puts, but your calls and puts must be fully covered and secured by your cash reserves.
In contrast, margin accounts often allow you to make many kinds of unsecured, complex trades, including shorting stocks and writing naked options.
However, brokerages reserve the right to decide what trades each investor can do on an individual basis.
Cash Account vs. Margin Account FAQs
Q: Can I trade on margin with my IRA?
No. The IRS forbids IRA funds to be used as collateral. If the IRS determines that you used money in your IRA as collateral for a margin account loan, you will owe income tax on the entire account amount, along with potential penalties.
Q: Can I receive dividends in a margin account?
Not really. You won’t receive any actual dividends because the lender is the official holder of shares traded in a margin account. However, you will receive “payments in lieu of dividends,” which may be taxed differently.
Q: Can I have both a cash account and a margin account?
Yes! Some brokerages will allow you to open both types of accounts. However, always ask first when signing up. Also, keep in mind that some brokerages don’t offer margin accounts at all.
Q: Can I switch from a cash to a margin account?
Yes, many brokerages allow you to upgrade from a cash account to a margin account. Be sure you are clear on the process before requesting a swap, however. It might take a few days to complete, during which time you’ll be unable to trade.
Cash Account vs. Margin Account: Which Is Better?
Most investors — particularly beginning investors — will find cash accounts meet all of their needs. It’s also probably not a good idea to take on the risk that comes with margin accounts until you have some trading experience under your belt.
However, if you’re looking for flexibility in what strategies you can trade, know what you’re doing, and can handle the risk, margin accounts can provide you with valuable tools.
To learn more about how you can go beyond trading stocks and bonds and ramp up your profit potential, visit the Pennybois University learning center.