Margin Account vs Cash Account: What's the Difference?
Selecting the right brokerage account is essential for Canadian investors, as it can significantly influence your trading strategy, potential returns, and risk exposure. Margin account vs cash account are two common choices, each with distinct principles.
Cash accounts are straightforward, allowing you to invest only the funds you possess, promoting financial discipline aligned with the principle of living within your means. On the other hand, margin accounts provide leverage, enabling you to borrow funds to potentially enhance gains, but they also increase risks and require a comprehensive understanding of the market.
Moving on, the purpose of this blog is to provide the Canadian investors with a comparative analysis of the margin account vs cash account to help them invest smarter.
What is a cash account?
A cash account is a non-registered investment account perfect for investors who have maxed out their registered accounts' contribution limits. It enables you to buy and sell securities using only the funds you've deposited, with no borrowing option. This ensures you invest strictly within your means.
Funds are typically transferred digitally from your bank to your brokerage account, and transactions must be settled by the settlement date, usually one business day after a trade. You can fund your account easily via debit card or bank linking. Cash accounts support trading in stocks, bonds, ETFs, mutual funds, REITs, money market funds, and cryptocurrencies, but generally do not allow options trading.
Benefits of cash accounts
Facilitates budget management: Investors can plan their investment portfolios based on the amount of money in their cash accounts. For example, if an investor sets a monthly budget of $2,000 in their cash account for stock investment, they can choose the right stocks based on this budget.
Reduce interest expenses: Unlike margin accounts, cash accounts do not require interest payments on margin loans.
Reduce the risk of bankruptcy: Since transactions in cash accounts are based on the cash balance in the account, investors will not face the risk of being unable to meet margin calls due to market fluctuations, resulting in forced liquidation or even bankruptcy.
Drawbacks of cash accounts
Lack of leverage: Cash accounts do not offer leverage. Leverage can allow investors to control assets of greater value with less of their own capital.
Limited trading options for investors: Cash accounts generally do not support short selling, and they typically do not allow the purchase of options or futures. If you want to make this type of investment, you will need to open a margin account.
What is a margin account?
Unlike cash accounts, investments in margin accounts carry a higher risk. A cash account only allows you to invest the cash amount in your account, but a margin account allows investors to borrow funds from a broker to purchase securities, options, futures, etc. Below are some key features of margin account:
A margin account has a leverage effect: It allows investors to control assets of greater value with less of their own funds, such as amplifying the purchasing power of funds in futures trading.
Risks and benefits coexist: While there is potential for increased returns, losses can also be magnified if the market moves unfavorably.
Benefits of margin accounts
Improve funds utilization: One of the most significant advantages of a margin account is its leverage effect. For example, in foreign exchange margin trading, investors can use leverage multiples (such as 50 times, 100 times, etc.) to expand the scale of transactions, which greatly improves the utilization rate of funds.
Complex investments are available: Investors can participate in trading of various financial instruments such as stocks, bonds, futures, foreign exchange, etc. through margin accounts. For some institutional investors, margin accounts help them build complex portfolio strategies, such as hedging strategies.
Provide more trading flexibility: Investors can adjust their positions at any time based on their market judgment and risk tolerance. For instance, in futures trading, if investors believe that the market price will rise, they can open a position and buy through a margin account; if the market trend changes later, investors can lock in profits through reverse operations (selling to close the position).
Drawbacks of margin accounts
Exaggerating risks: Leverage is a double-edged sword; while it can amplify your gains, it can also significantly increase your risks. Let us take stock margin trading as an example. If an investor purchases stocks with a 50% margin ratio, when the stock price drops by 20%, the investor's loss will reach 40% (relative to the principal).
Interest and fee costs: Some margin accounts involve interest costs. For instance, when investors borrow funds through a margin account to trade, they are required to pay interest on the borrowed amount. In addition, margin accounts may incur other fees, such as trading commissions and account maintenance fees, which means that investors have to bear higher costs when trading.
Minimum balance limit: Some brokerages need you to have at least a few thousand Canadian dollars before you can open a margin account.
Margin account vs cash account
Now, you have a general understanding of margin accounts and cash accounts. Below is a comprehensive comparison of margin account vs cash account.
Use of funds
Margin account: Funds are mainly used as margin for transactions, allowing investors to trade using leverage. For instance, in futures trading, after depositing a certain percentage as margin, investors can control futures contracts worth several times the margin amount. For example, if the margin ratio is 10%, a margin of 100,000 Canadian dollars can trade futures contracts worth 1 million Canadian dollars. The purpose of these funds is to ensure that investors have sufficient capital to cover potential losses and to facilitate the smooth progress of trades.
Cash account: On the other hand, for cash account, it's a very different situation compared with margin account. The funds are used solely for the full payment of purchased securities or assets, without any leverage. If an investor has $100,000 in a cash account, he or she can only buy $100,000 worth of stocks.
Risk level
Margin account: Margin accounts have higher risk than cash accounts. Due to the existence of leverage, the risk is magnified. When the market moves unfavorably, investors may suffer huge losses.
Cash account: However, if an investor uses a cash account to buy stocks, even if the stock price drops to zero, the investor's loss is only the total cash spent on purchasing the stocks. There will not be a situation where the loss exceeds the principal due to leverage as in a margin account.
Returns potential
Margin account: It has higher returns potential because leverage can be used. When the market moves favorably, investors can achieve higher returns than with a cash account. For example, in foreign exchange margin trading, the leverage ratio may reach 100 times. Assuming that an investor uses a margin of $1,000, he or she can control a foreign exchange transaction of $100,000. If the foreign exchange rate moves in the investor's favor, the profit will be exaggerated by the leverage ratio.
Cash account: Returns mainly depend on the natural growth of asset prices. For example, after buying stocks and holding them in a cash account, you can only earn returns if the stock price increases or you receive dividends. These returns are relatively stable and won't experience the large fluctuations seen in margin accounts due to leverage.
Trading options
Margin account: Margin accounts allow for more investment strategies. Just I mentioned before, margin accounts allow investors to trade with leverage, which means that investors can control assets of greater value with less of their own capital. In addition, margin accounts provide opportunities for short selling. Short selling means that when investors expect asset prices to fall, they first borrow assets from brokers and sell them, and then buy the same amount of assets back to the broker after the price falls, thereby earning the difference.
Cash account: However, cash accounts do not support leverage and short selling. In the stock market, investors can use a margin account to borrow stocks for short selling. This kind of operation isn't possible with a cash account. With a cash account, investors can only buy and hold stocks when they expect prices to rise, waiting for the price to increase in order to earn a profit.
Interest costs
Margin account: When investors borrow funds for trading through a margin account, they need to pay interest. In stock margin trading, if an investor uses the borrowing feature, they must pay interest to the brokerage at a certain rate. This interest expense increases trading costs and reduces actual returns.
Cash account: However, cash accounts generally do not incur interest charges like margin accounts because cash accounts are traded with the investor's own funds. For example, if you use $100,000 from a cash account to purchase stocks, this $100,000 is your own money, and there is no borrowing involved. Therefore, no interest expenses will be incurred.
Choosing between a cash or margin account
After you understand the comprehensive comparison of margin account vs cash account, a question may arise in your mind: which is better, cash account or margin account?
Whether to choose a margin account or a cash account should depend on the investor's situation. If investors pursue high returns, can bear high risks, have rich trading experience and want to use advanced strategies such as leverage and short selling, they can choose a margin account.
On the contrary, if investors prefer stability, have low risk tolerance and lack experience, they are more suitable for a cash account, which mainly makes profits through the natural appreciation of assets, and the risks and returns are relatively stable.
How to open margin account on moomoo?
Canadian investors can open individual margin accounts in moomoo Canada. An individual margin account is held by one person who is the sole owner of the assets, which allows you to trade using cash, margin, or portfolio margin.
An individual margin account offers the following benefits for Canadian investors:
Deposit US and Canadian dollars.
Trade US stocks and CA stocks directly.
Low market margin loan rates.
Use cash or securities in the account as margin to enlarge your buying power.
Margin accounts are not subject to PDT (pattern day trading) restrictions.
Start margin trading
Margin will be used by default if you do not have enough cash when buying a stock.
Start short selling
Short sell by tapping Sell on the Trade page when you do not have a long position in a stock.
