Investors put their money in shares, as opposed to an interest-bearing savings account, because of the potential for high returns. Buying stocks on margin makes these earnings even more lucrative. To clarify, your margin balance is how much a broker is willing to lend you in investment capital. However, not many people understand how this works and what the differences are between a margin vs cash account.
In order to maximize your stock market returns, you need to have a sizable amount of money. For example, if you had $300 in savings, an investment portfolio with a 15% annual growth would earn you $45 per year or $3.75 per month. This isn’t a very large amount, especially if it takes you hours to research potential investments and analyze companies’ earnings reports. In other words, it is much easier to open an interest-bearing savings account, even if it offers smaller returns.
Having said all that, margin brokerage portfolios exists for this very reason. Many firms will lend investors at least the same amount as their deposited funds, if not more. In addition to this, when buying stocks on margin, your trades will settle almost immediately. Furthermore, if the margin balance permits, you may even withdraw some cash from your account without having to close any current positions.
Margin vs Cash Account: The Main Differences
To illustrate how each of the two account types work, let’s look at an example of an investor who has $1,000 to put in the market. When they open a cash portfolio, they can only use their deposited amount to buy/sell shares.
A margin account, on the other hand, gives them more. In most cases, brokerage platforms will give you a margin balance that is equal to the available funds in your account.
In our above instance, the investor would get up to $2,000 that they can use in the market. After that, if they generate ten percent in returns for the year, their profit is equal to $200.
At this point, the investor’s cash balance is $1,200. Since their available margin is twice that amount, they would have $2,400 (double the $1,200) that they can buy shares with.
With a cash account, the same investor’s ten percent returns would’ve only been $100. In addition, their new balance would be $1,100 (their initial $1,000 deposit plus the $100 in profits).
Your Margin Balance and Trade Settlement Times
Executed buy and sell orders take a longer time to process with a cash account. More specifically, you would have to wait two to four days until you officially own a stock (when you buy) or receive the cash (when you sell).
Margin account transactions, on the other hand, settle on the same day, if not instantly. In turn, you can immediately reinvest your funds (after selling stocks) and generate more profits.
With a cash account, you will likely not realize these returns because of the trade settlement waiting time. In fact, if you had a new stock or investment idea in mind, its price could become too expensive by the time you receive the cash.
Banking and Investments
Buying stocks on margin especially benefits the holders of a health savings account, as well as any investment portfolio that is designed to take care of emergencies.
After all, the money is there to pay for these specific expenses.
If a urgent situation arises, households can withdraw funds from their margin balance. Therefore, they aren’t forced to sell shares (and compromise their returns) when they need to access cash.
Going back to the example of the investor who deposited $1,000 in their portfolio, assume that they only use $750 of their money to invest (and not the full amount).
Firstly, the margin allows them to buy stocks worth $1,500 (which is double the $750 in capital that they utilized). In turn, this leaves them with $250 in uninvested money.
With a margin account, they may withdraw the $250 without having to close any of their open positions. This feature is more than ideal during urgent medical events.
Even if a consumer has to close some positions, emergencies can’t wait for the transaction to settle. A margin account allows them to sell some of their stocks (if needed) and, after that, the proceeds are immediately available for withdrawal or to spend on a debit card.
Keep in mind that many brokerage firms offer banking services, particularly when it comes to a health savings account.
Managing Risks: Margin vs Cash Account
Investors that have a cash portfolio cannot engage in certain types of financial transactions. Short-selling shares and buying options contracts are only possible through a margin account.
To clarify, short-selling is the practice of borrowing stocks from a broker, selling them for a high price, and then buying them back when they become cheaper. Consequently, the short-seller makes money when share values go down.
This strategy helps you minimize your losses during market downturns. Some traders also use options contracts (which are more complex in nature) to manage their risks.
Either way, these strategies are not available on a cash account. Only margin portfolios allow you to short-sell or buy options contracts.
Buying Stocks on Margin: A Risky Approach
Just as borrowing money from the broker and investing it can balloon your profits, it also exacerbates your losses when prices go down. This a main reason why investors avoid margin accounts.
However, cash portfolios don’t solve the problem. After all, any market participant must learn how to manage their risks, regardless of the account type or how much money they want to invest.
To clarify, if you can’t minimize your losses, then you will run into the same problem whether you are investing through a cash account or buying stocks on margin.
Equally as important, college students and younger investors don’t have a lot of trading capital. Furthermore, because they are decades away from retirement, these market participants have a relatively flexible risk tolerance and more time to recover from losses.
A margin account is certainly more suitable than a cash portfolio for young traders and those who want to invest money while they’re in college.
Margin vs Cash Account: Which One?
Buying stocks on margin allows investors to maximize their returns, access a larger amount of trading capital, and utilize different risk-management strategies.
Above all else, when deciding between a margin vs cash account, transaction settlement times are crucial. While the latter requires you to wait several days until a trade is completed, sales and purchases on a margin portfolio are immediately processed.
What was your return on investment last year? If you haven’t bought any stocks yet, how much do you expect your earnings to be when comparing a margin vs cash account?
Wouldn’t it be nice to double them? A margin balance allows you to do so for the same amount of money and research time.