Types Of Brokerage Accounts

When you decide to start investing in the stock market, you have to somehow actually pay for the stocks you buy. Most brokerage firms offer investors several different types of accounts, each serving a different purpose. Three of the most common types in the following sections.

The basic difference boils down to how particular brokers view your “creditworthiness” when it comes to buying and selling securities. If your credit isn’t great, your only choice is a cash account. If your credit is good, you can open either a cash account or a margin account. Once you qualify for a margin account, you can (with additional approval) upgrade it to do options trades. To open an account, you have to fill out an application and submit a check or money order for at least the minimum amount required to establish an account.

Cash accounts

A cash account means just what you think it means. You must deposit a sum of money along with the new account application to begin trading. The amount of your initial deposit varies from broker to broker. Some brokers have a minimum of $10,000, while others let you open an account for as little as $500. Once in a while you may see a broker offering cash accounts with no minimum deposit, usually as part of a promotion. Qualifying for a cash account is usually easy as long as you have cash and a pulse.

With a cash account, your money has to be deposited in the account before the closing (or settlement) date for any trade you make. The closing occurs three business days after the date you make the trade (the date of execution). You may be required to have the money in the account even before the date of execution. In other words, if you call your broker on Monday, October 10, and order 50 shares of CashLess Corp. at $20 per share, then on Thursday, October 13, you better have $1,000 in cash sitting in your account (plus commission).Otherwise, the purchase doesn’t go through.

If you have cash in a brokerage account, see whether the broker will pay you interest on the uninvested cash in it. Some offer a service in which uninvested money earns money market rates and you can even make a choice about whether the venue is a regular money market account or a tax-free municipal money market account.

Margin accounts

A margin account gives you the ability to borrow money against the securities in the account to buy more stock. Because you have the ability to borrow in a margin account, you have to be qualified and approved by the broker. After you’re approved, this newfound credit gives you more leverage so that you can buy more stock or do shortselling.

For stock trading , the margin limit is 50 percent. For example, if you plan to buy $10,000 worth of stock on margin, you need at least $5,000 in cash (or securities owned) sitting in your account. The interest rate that you pay varies depending on the broker, but most brokers generally charge a rate that’s several points higher than their own borrowing rate.

Why use margin? Margin is to stocks what mortgage is to buying real estate. You can buy real estate with all cash, but many times, using borrowed funds makes sense since you may not have enough money to make a 100% cash purchase or you prefer not to pay all cash. With margin, you could, for example, be able to buy $10,000 worth of stock with as little as $5,000. The balance of the stock purchase is acquired using a loan (margin) from the brokerage firm.

Option accounts

An option account gives you all the capabilities of a margin account (which in turn also gives you the capabilities of a cash account) plus the ability to trade options on stocks and stock indexes. To upgrade your margin account to an options account, the broker usually asks you to sign a statement that you’re knowledgeable about options and familiar with the risks associated with them.