When starting out as an investor, you will have to decide how to set up your investment accounts. You have to start by asking yourself if you want to set up both a cash account and margin account or just one of the two. Before making this decision, here are some factors you should consider.
What is a Margin Account?
According to the experts at SoFi, a margin account is a riskier form of trading account allowing investors to borrow money from their brokerage to purchase stocks and other securities. Investors typically use margin accounts to trade in higher-risk, volatile investments. Brokerages charge interest on any balance you maintain in a margin account. Like cash accounts, you must fully pay for your trades at settlement. Most brokerages allow traders to open a margin account only if they meet certain minimum net worth and income requirements.
What is a Cash Account?
A cash account allows you to invest with your own money only. They require you to maintain a specific balance at all times. If you do not keep your account at a minimum threshold, institutions may charge an additional maintenance fee.
Cash or Margin Account: Which Do I Need?
Before you decide between cash or margin account, let’s take a look at the difference between the two:
- You can only invest up to $2,000 with a cash account. You must invest any amount over that in a margin account.
- When you invest on margin, there is no predetermined interest rate for your loaned funds. Your brokerage firm can change its rates at any time without notice. This may create added risk when choosing to invest using margin. Margin interest rates also fluctuate throughout each day, so they are subject to market conditions.
- The higher your loan-to-value ratio, which is calculated by dividing your current investment balance by your account’s value, or margin percentage, the greater risk you are taking on.
- You can leverage your margin account to borrow money from your broker to buy more stocks than you could have purchased if you had invested all of your own money into them.
- As long as you keep your loan-to-value ratio below 70%, it can be a good way to invest more money in your brokerage account without having to save up for that extra capital all at once.
- If you’re investing in stocks, a cash account is preferable because it allows you to buy shares at a low cost (the transaction costs are slightly higher with margin).
The best account to use depends on your trading strategies. The biggest factor in deciding between a cash and margin account is whether you’ll be able to meet your required minimum equity balance.
A cash account is probably your best bet if you’re just starting with investing and have limited resources. However, a margin account may be right for you if you find yourself in a situation where you need additional funding to make trades that align with your strategy.