Step 4 Type of Brokerage Account - Cash vs. Margin

Once you choose a broker, you will have a choice of opening a margin account and a cash account.

The Cash Account: A cash account is one in which you must always pay for your shares by the settlement date (usually 3 days after you make the purchase). Most brokerages will require that you have the money in your account before you even make your purchase unless you have a good track record. This type of account can be limiting if you are buying and selling frequently. If you do not pay for your stock by the settlement date, your account can become restricted. This means that you can only buy shares if the money is in your account before you enter the trade. This can be quite limiting since you might want to buy a stock quickly and not want to have to wait until you have deposited money into your account.

The Margin Account: The margin account is like a cash account except that you can borrow money against your marginable securities. That means you can borrow up to 50% of the value of stocks eligible for margin. Generally, stocks trading above $5 are marginable but each brokerage firm has its own rules. Generally stocks at $5 or below are not eligible for margining.

Margin is a cheap way for you to borrow since there are no fees for buying on margin except of course commissions, and the interest rate charged is lower than the prime rate.

Buying on margin is a risky venture however. If the stock on which you based your margin goes down in price then you'll have to add money or more securities to your account to borrow against. Read your brokerage’s margining rules very carefully.

Why do people buy on margin? The biggest reason that some investors buy on margin is that an investor can buy more stock. For example, by only having to pay for 50% of the stock amount and relying on the brokerage to lend you the other 50%, you can buy twice as much. Investors who buy stock on margin usually think that their chosen stock is going to rise and hence they want to maximize their profit. We do not recommend margining since if the stock falls instead you will have to cover the amount lent by the brokerage to you.

The second reason is ease of access to additional funds without having to put down the money yourself as long as the underlying margined stock is not falling in price.

<< Return to Investor Education