Cash Accounts - Covering the Basics
When investors make securities transactions, they have different account options depending on their investment goals: cash accounts and margin accounts.
What type of account is cash? Cash accounts are fairly straightforward since all transactions must be made with available cash in the account. But they do come with some restrictions.
Read on to learn more.
What is a cash account?
A cash account is a type of brokerage account where investors must pay the full amount for the securities they purchase when using this account type. But first, they must have enough cash in their account to cover their entire trade on the same day that it trades so when the trade settles, there's enough cash available.
Cash is commonly deposited via ACH (an electronic, bank-to-bank money transfer processed through the Automated Clearing House (ACH) network). This usually takes two to three business days to settle in an account and be available for trading. This cash deposit needs to be settled before the trade settlement date to avoid an account violation.
How cash accounts work
As we explained above, transferring cash into an account via ACH to cover a trade takes a few days to settle, so the investor should consider this timeframe as the settlement period for a buy order is typically T+1 (trade date plus one business day) to avoid potential account violations.
Unlike margin accounts, cash accounts don’t allow short selling or trading on margin. Investors can’t borrow against the value of their assets. Common violations on cash accounts to avoid include selling a security to cover a purchase made with unsettled funds (cash liquidation violation).
Investors must also avoid good faith violations, which means buying and then quickly selling a security before fully paying for the purchase with settled funds as well as free-riding violations which entail paying for a security with the sale of the same security.
Examples of cash accounts
Individual brokerage account: Allows investors to buy and sell a variety of securities, such as stocks, bonds, mutual funds, and ETFs, using the available cash in the account.
Custodial accounts: Set up by an adult for a minor. The custodian manages the account until the minor reaches adulthood (age varies by state). This type of cash account can hold various investments and is used to save for the minor's future expenses.
Joint accounts: Held by two or more individuals, typically spouses or family members. All account holders have the authority to make transactions using the funds available in the account, which can include buying securities or withdrawing cash.
Business brokerage accounts: Set up in a brokerage firm, this allows the business to invest surplus cash into securities. This can be useful for managing corporate funds and achieving investment growth.
Why do cash accounts matter?
Cash accounts are significant for several reasons, particularly for individual investors seeking a straightforward and relatively low-risk way to engage with the financial markets when compared to margin accounts.
This account type can help investors avoid taking on debt and the associated interest costs. It can reduce the complexity of trading as there's no margin requirements or potential margin calls and it can promote disciplined investing; investors can only make transactions using their cash funds, generally encouraging more active financial management and planning.
How to open a cash account
Step 1: Choose a brokerage or online trading platform that you'd like to do business with. Please note that moomoo currently offers cash accounts!
Step 2: Typically complete an application online in under 15 minutes. Most states will require investors to be at least 18 years old to open an account, but some firms may allow parents to set up accounts for their kids, such as a custodial account or a teen-owned brokerage (investment) account.
Step 3: Fund the account by either depositing or transferring funds. This can be done through bank transfers, checks, or transferring assets from another brokerage firm.
Potential pros and cons of cash accounts
Potential pros
Lower risk: No risk of incurring debt or interest charges, making it a potentially safer option for investors with a low risk tolerance.
Simplicity: Offers a straightforward way to trade securities without the complexities of margin requirements or the risk of margin calls.
Reduced stress: Absence of margin calls means investors usually won't face the pressure of meeting equity requirements or the potential for forced sales of their investments.
Potential cons
Limited buying power: Without the ability to borrow funds, investors can only purchase securities with available cash, potentially limiting their investment opportunities.
Slower growth potential: Cash account returns might be lower compared to margin accounts, especially in rising markets, since there is no leverage to amplify potential gains.
Liquidity requirements: Must have enough liquid assets to fund their transactions since they cannot rely on borrowed capital.
Cash account vs. margin account: What's the difference?
A cash account requires investors to pay the full amount for securities they purchase. It's a basic account that doesn't allow for borrowing money from the broker to make trades; it eliminates the risk associated with leverage.
In a margin account, investors can use margin to leverage their positions. They can borrow against the value of the assets in a margin account to purchase new positions or sell short. Margin can also be used to make cash withdrawals against the value of the account in the form of a short-term loan.
It's important to keep in mind that when a margin balance (debit) is created, the outstanding balance is subject to a daily interest rate charged by the firm. These rates are based on the current prime rate plus an additional amount can be high and it is charged by the lending firm.
FAQs about cash accounts
What type of account is a cash account?
An individual brokerage account is an example of a cash account. The account type requires an investor to pay the full amount for securities purchased. Cash accounts don’t let the account holder borrow funds from the broker-dealer to pay for transactions. They're limited by the cash balance deposited by the investor and potential losses are capped at the amount invested.
What is the difference between a bank account and a cash brokerage account?
A bank account records all bank-related transactions, such as goods purchased or sold, expenses paid, and income received through checks or bank drafts. It can provide features like overdrafts, direct debit payments, and online banking. It's typically used for managing day-to-day financial activities; it may earn interest on the balance.
A cash brokerage account is a type of brokerage account where investors must pay the full amount for securities they purchase in cash. This means that investors cannot borrow money from their broker-dealer to pay for transactions. For example, if an investor wants to buy $1,000 worth of stock, they must have $1,000 in cash in their account before the buy order settles, which is usually one day after the order is placed.
Is a cash account a savings account?
No, a cash account is not the same as a savings account. A cash account, typically used in the context of brokerage services, is designed for buying and selling securities using the cash available in the account. It provides a straightforward and lower-risk method for engaging with the financial markets.
A savings account is a deposit account held at a bank or financial institution that pays interest on the money deposited. Savings accounts are intended to store money securely while earning a modest interest rate, and they do not generally facilitate the buying and selling of securities.
