Every time someone wants to open a brokerage account, they will find a question ‘Do you want a cash account or margin account?’.
Knowing the differences between a cash account and a margin account is essentials for investors, especially those who have just tried investing.
There are major differences between the two, in both positive and negative. Once investors know the differences, they will choose the best account that suits their needs.
Cash account may seem traditional since investors need to pay any trades in cash, by the required settlement date. Besides, this account also does not allow investors to borrow money from either the broker or financial institutions.
Consequently, this account can restrict investors the ability to place trades more often as you may not have enough available cash settled at the moment they want to place their next buy order.
Other than that, investors also need to wait until trade settlement to make a withdrawal of cash raised from a sell order. One more thing, stocks held in a cash account are not lent out by the brokerage to short sellers.
Meanwhile for investors holding securities within cash accounts will never be subject to a margin call. What’s more? Having a cash account will also save investors from losing their assets due to rehypothecation exposure.
Rehypothecation is a condition where the broker uses the investor’s shares as collateral for the broker’s loans from third parties.
Additionally, with a cash account, the investor does not have the ability to short any stocks.
In the margin account, investors have the ability to borrow money from their broker in order to make an additional investment or to leverage return. However, investing in the margin is risky and is not necessary for many investors.
Sometimes, without investors knowledge, securities they hold in their margin account can be lent out to short sellers to generate additional income for the broker.
That results in their inabilities to claim the dividend as a qualified dividend subject to much lower tax rates. Then, they must instead pay ordinary personal taxes on the dividend income.
Additionally, they may also be subject to rehypothecation exposure.