Cash Account vs. Margin Account: Which One is Right for You?

Cash accounts and margin accounts are both types of popular investment accounts for trading and market access. Although the two accounts offer similar trading functions — and are both offered by some of the best stock trading apps — cash accounts and margin accounts vary when it comes to how they are funded, the level of risks involved, and trading strategies. 

Here's how cash and margin accounts compare.

Quick tip: You can open a margin brokerage account with popular investment platforms like Charles Schwab, Fidelity, Robinhood, and Interactive Brokers. 

What is a cash account?

Cash accounts are a type of brokerage account that pulls from existing investor funds to buy and sell securities like stocks and ETFs. The cash generally isn't physical cash, but rather the digital equivalent, like money from your checking account that goes into your brokerage account.

You won't be allowed to purchase securities if you lack adequate funding. Transactions through cash accounts must be paid in full by the settlement date, which typically is one business day after an order is placed. You can deposit funds into a cash account easily, such as via a debit card or by linking a bank account. 

Cash accounts hold and buy securities such as stocks, bonds, ETFs, mutual funds, REITs, money market funds, and cryptocurrencies. Most cash accounts don't offer options contracts. 

Definition of a cash account

As the name implies, cash accounts are funded in full by cash, as opposed to borrowed money. In order to place a buy order, you need enough cash in the account to fully cover the transaction by the time it settles.

Usually, this means depositing as much cash as the order amount, although some of the best online brokerages allow cash account holders to use the proceeds from investment sales to place buy orders before settlement, as long as the cash will hit your account in time before settlement occurs. 

For example, if you want to buy $1,000 worth of a stock, you need to deposit $1,000. Some brokers front you the money while your deposit transfers, even for those with cash accounts, because the cash is en route, so you're not really borrowing the money like a traditional loan. Others, however, make you wait until the transfer is complete. 

Benefits of a cash account

A cash account is a basic type of investment account, but its simplicity is not necessarily a bad thing. There are several benefits to cash accounts, such as the following:

Beginner-friendly

Cash accounts are straightforward, beginner-friendly brokerage accounts suitable for all kinds of investors. The cash you deposit into your account is what you have available to purchase new securities. There's no need to worry about lending amounts or accruing interest. What you see is what you get. 

Buy-and-hold strategy

If you purchase a stock and its value falls, you can hold on to it to see if it rises again in the long term. Ideally, you can withstand ups and downs and come out on top down the line. This is referred to as a buy-and-hold strategy, which is often best for long-term growth. With a margin account, a broker may force the sale of a certain asset if its value drops significantly below the required equity amount. But with a cash account, you won't be forced to sell at a loss. 

Prevents overspending

Since cash accounts only allow you to spend money that you already have, there's less risk of overspending on investing. You could still put more into your brokerage account than what's arguably prudent — perhaps you should be keeping more in your savings account, for example — but you at least avoid the risk of investing money that you literally do not have, as can be the case with margin accounts.

Lower risk of losses

By only investing what you have in cash, there's a lower risk of losses, compared to margin investing. With margin, you're borrowing money, so you might lose even more money than you put in. That said, all investing carries risk, and much depends on what you invest in, rather than the type of account.

Drawbacks of a cash account

While cash accounts have several advantages, there are also potential drawbacks, such as the following:

Less flexibility

You won't get the same level of flexibility as you would with a margin account. You're limited to the cash in your account. So if you want to buy a certain security that is out of your price range, you'll either have to find another means of affording it or miss out altogether.  

Lower potential returns

Because cash accounts only let you invest the amount of cash you have, the return potential is lower compared to margin investing. That's not because the investment itself performs better or worse, but it's a matter of using leverage or not to amplify returns. For example, if you invest $100 in an ETF that gains 10%, you'd gain $10. But if you invest $100 of your own cash while borrowing $100 in a margin account to invest $200 in that same ETF that gains 10%, you'd gain $20. The risk, of course, is that the opposite could happen and you could have amplified losses in a margin account.

Limited trading options

Cash accounts don't allow for short selling, nor do they typically permit investors to purchase options or futures. It depends on individual brokerages or investment apps, but in many cases, if you want to engage in this type of investing, you need to open a margin account, even though you might not be using margin to make some of these investments.

How to open a cash account

Opening a cash account through a brokerage is simple, as cash accounts are generally the default option. At most, you would likely just select between a cash account and a margin account during the sign-up process. During this process, you may also have to give the following information:

• Legal name
• Employment status
• Risk tolerance
• Time horizon
• Social Security number
• Age
• Bank account information
• Legal ID (such as a driver's license or passport)

Minimums and fees vary from platform to platform. Make sure the brokerage you open your account through offers what you're looking for before you sign up. For example, if you're a socially conscious investor, you might prefer an app that has curated ESG portfolios. Or you might prefer a brokerage with minimal fees that lets you take more of a do-it-yourself approach.

What is a margin account?

While cash accounts only let you invest the amount of cash you have in those accounts, margin accounts let you use margin, i.e., borrowed money. You essentially get a loan from the broker for a certain amount of money that you can invest, based on factors such as your account balance and the size of the investments you want to make on margin.

Also, like a traditional loan, money borrowed from a broker must be paid back with interest.

"Monthly margin interest is added to the margin balance and will cause the margin to grow exponentially until the margin is paid down or off," says Sandi Bragar, CFP and chief client officer at Aspiriant Wealth Management. "If the margin was used to buy an investment, the investor may be able to deduct some/all of the margin interest expense from their taxable income."

Margin accounts offer increased flexibility compared to cash accounts. However, you should be aware of substantial risks before opening a margin account, such as the potential for greater losses, increased volatility, and forced sales. 

Definition of a margin account

Margin accounts are brokerage accounts that offer margin trading options to investors. Just like a cash account, you can deposit money into your account to buy securities. But you can also buy securities with borrowed money from your broker, although you can only borrow up to 50% of the purchase price of a security, with some brokers having lower limits.

How margin trading works

You can open a margin account with most online brokerages or investment platforms. Make sure to compare interest rates, minimums, fees, and more between different platforms before opening a margin account. 

The process is nearly the same as opening a cash account, but you'll likely need to meet additional requirements, such as a higher account minimum — often at least $2,000.

Securities purchased through margin don't have to be paid in full by the settlement date. Instead, you can borrow money to partially pay for the purchase — the maximum allowed is generally 50% of a particular investment, although some brokers have lower limits. 

At 50%, for example, if you want to purchase a stock that is priced at $50 per share and you have $2,000 in your account, you can purchase up to 80 shares worth $4,000. You'll owe $2,000. 

You'll essentially be acquiring a loan with margin investing. Depending on your brokerage's policy, you'll have to back the contents of your loan by a set time (including any accrued interest). You'll have to pay back your margin loan even if your investment's value plummets.

Also, there's a limit on how much of your total portfolio can be based on margin. In the U.S., federal rules require brokers to set a minimum 25% equity requirement, meaning the value of your margin loan can not exceed 75% of your overall account balance. This is known as the maintenance margin, and some brokers have higher equity requirements. 

This equity equals the cash you put in plus any realized or unrealized investment gains. A big risk, however, is that if your investments start to lose value, you could fall below that 25% equity amount, even if you put in a lot of cash initially. 

For example, if you purchased 100 shares of a stock at $50 per share using $2,500 in margin and $2,500 in cash, your equity would initially be 50% ($5,000 total stock value - $2,500 margin). But if the share price fell to $33.33, your equity would drop to 25%. That's because the total value of your 100 shares would be $3,333.33, and since you still owe $2,500 on margin, your equity would be $833.33, which is 25% of the total value. It no longer matters that you initially put in $2,500, because that amount has since been lost.

Margin accounts also enable investors to engage in short selling, where you're essentially betting on the price of a security going down. However, there are theoretically no limits to how much you can lose when short selling, as the more the security increases in value, the more you owe, so margin limits would likely kick in and you might face margin calls or forced sales.

Risks and rewards of a margin account

Using a margin account is more complex and risky than using a cash account, but there are also several potential benefits of a margin account.

For one, you'll likely be able to purchase more shares of certain securities with a margin account. If the security increases in value, you'll receive even higher returns compared to if you had purchased half the amount of shares through a cash account. The flip side, though, is that your losses can be higher than if you didn't use leverage in margin trading. You might even lose more than you put in, such as if you invest $1,000 and borrow $1,000 to make a $2,000 investment, and the stock then craters to where you can only sell it for $500, meaning you've lost your initial $1,000, plus you have to put in another $500 to pay back the remaining margin amount. 

Plus, the maintenance margin requirement can negatively impact your investment returns and strategy.

If an account falls below this minimum, an investor may receive a margin call that demands additional cash or more securities to be bought so the total equity value of the account increases. 

You typically have around five days to meet the minimum requirement. If not met, you may be charged a commission on the transaction or your broker may close any open positions without your approval, in what are known as forced sales. 

"Margin calls can be particularly painful for investors who are forced to sell investments that have significantly declined in value to meet the net equity requirement for the brokerage account," states Bragar.

Also, options and futures contracts are generally only available to investors with margin trading enabled. Futures and options can be a good way to diversify your investment portfolio, hedge against the market, mitigate risk, and earn additional gains. If you don't know what you're doing, however, or if you treat it as speculation, investing in options or futures can increase risk. Only experienced investors with knowledge of the market should buy futures or options contracts. 

Key differences between cash and margin accounts

If you just looked at the homepage of someone's brokerage account, you might not be able to tell if they have a margin or cash account. But there are some key differences below the surface in how these accounts can be used.

Leverage: cash vs. margin

A key difference between cash vs. margin account trading is that margin accounts use leverage, while cash accounts do not (unless you got the cash from an external loan not associated with the brokerage account). With leverage, you can amplify both gains and losses, because you're also getting the investment returns from whatever you purchased with borrowed money.

For example, if you invest $10,000 in cash and $10,000 in margin to buy 100 shares of a stock that goes from $100 to $200 per share, you're more than doubling your money. The total value goes from $20,000 to $40,000, and after you pay back the $10,000 in margin (ignoring interest for simplicity's sake), you're left with $30,000, meaning you tripled the $10,000 cash you actually invested. However, you could end up losing more than you put in due to leverage, so it's important to be aware of the risks and be prepared to pay back what you borrowed no matter what.

Settlement of trades

These accounts also differ in how they treat trade settlement. In the US, the T+1 cycle means that exchange-traded securities typically settle after one business day, so if you sell a stock on Monday, the cash will be in your account on Tuesday. 

With a cash account, you might not be able to use those funds until the trade settles, or you might at least be limited in your ability to quickly buy and sell based on unsettled funds. With a margin account, however, unsettled funds can basically be used however you want when it comes to making other investments. 

Risk exposure

In general, margin accounts lead to more risk than cash accounts. Not only can leverage amplify losses, but the risk of margin calls means you may need to quickly find cash to deposit into your account if your investments start losing value, or you may face forced sales of securities that you'd otherwise prefer to hold onto.

Advanced trading options

Most brokerages require you to have a margin account to trade options contracts or futures contracts, and you can also engage in short selling on margin. 

While a margin account is typically required for all futures trades, some brokerages only require it for specific options strategies, such as selling uncovered puts or calls. However, simpler options strategies, like buying calls or puts, may be available to some cash accounts.

When to use a cash account vs. a margin account

Cash accounts and margin accounts typically serve different types of investors:

When cash accounts are better

Cash accounts are typically the better option for beginners, hands-off traders, and investors with low-risk tolerances. Trading is simple with cash accounts and suitable for long-term wealth-building strategies like the buy-and-hold strategy. 

Bragar explains that beginners shouldn't worry about margin off the bat. "Get used to your new account first. Experience what it's like to buy and hold investments, monitor the account balances, and transfer money between the brokerage account and your checking account. Once you flex those muscles, consider adding the margin feature if and when there's a need."

Keep in mind that short selling, along with options and futures, aren't usually available with cash accounts. If that's something you're interested in, you'll probably have to open a margin account.

Before opening a margin account, make sure you understand all the risks involved with trading on margin. You can always talk with a professional like a certified financial planner (CFP) or another type of fiduciary advisor for professional guidance and advice. 

When margin accounts are better

For folks with more stock market expertise and higher risk tolerance, margin accounts might be suitable if the chance of higher gains and the flexibility of investing on margin is more appealing. However, the risks of margin accounts need to be carefully considered, and you may need to take a more active role in overseeing your account, such as to avoid situations like forced sales.

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