If you’re considering opening an account with a broker, you’ve likely discovered that there are a few different kinds of accounts you can open.
You’ve got cash accounts, margin accounts, retirement accounts, managed accounts, and more.
In this guide, we’ll be digging deep into the most common option: the cash account.
We’ll discuss what a cash account is, how it works, the benefits and limitations that come along with it, and how to go about opening one.
Definition of a cash account
A cash account is a type of brokerage account where the investor (the account holder) is required to pay for the full amount of securities purchased.
For example, if you want to buy $100 of Apple stock and you have a cash account, you have to have $100 available in your account. You can’t borrow money or use margin loans to make investments.
That kind of account might sound pretty obvious. It works just like your bank account. To really understand what a cash account is, then, it’s important to compare it to its counterpart, the margin account.
Cash accounts vs. Margin accounts
A margin account allows you to borrow money to buy securities through what is known as a margin loan.
The amount you can borrow depends on your broker’s margin requirements.
Say, for example, you want to buy that same $100 of Apple stock, but this time you have a margin account with a 50% margin requirement. You’d only need to have $50 available in your account, as the remaining $50 (50% of the investment) can be purchased using a margin loan.
With a margin account, you’re borrowing money to make investments. With a cash account, the investments you make are entirely with your own money.
Naturally, there are some pros and cons to each:
- Leverage. Margin accounts provide more leverage and increase buying power.
- Risk. Cash accounts come with lower risk as there is no debt involved.
- Interest. Margin accounts charge interest on borrowed funds.
As such, cash accounts tend to be a better fit for conservative or beginner investors, while margin accounts can be a smarter move for experienced or aggressive investors.
How cash accounts work
Cash accounts are pretty simple.
Once you’ve set up an account (we’ll discuss the steps involved shortly), you’ll need to add some funds. Your broker will let you know what methods are available for this, such as direct deposit or wire transfer.
When you want to purchase a security, you must have a sufficient available balance. Securities purchased using a cash account are subject to a T+2 settlement rule, meaning the trade must be paid for in full within two business days after the transaction date.
Once those funds are used to purchase a security, they cannot be reused until the trade settles, for example, once you’ve sold the stocks you purchased.
Unlike margin accounts, cash accounts don’t permit leveraging or short selling. However, any securities purchased using a cash account are owned outright by the investors, as there is no borrowing involved.
Finally, account holders are prohibited from engaging in "free-riding," where they sell securities before paying for them in full. You have to have paid for your security before you’re able to sell it.
Regulation T and cash accounts
Regulation T (often shortened to Reg T) is a Federal Reserve regulation that governs the extension of credit by brokers and dealers.
For holders of margin accounts, it prevents the investor from borrowing more than 50% of the purchase price.
For cash account holders, it prohibits free-riding and borrowing. It also requires that securities are paid for by the settlement date and the proceeds from sales can’t be used for new purchases until the trade has been settled.
Types of transactions allowed in a cash account
Certain types of transactions such as short selling and freeriding are not permitted with a cash account.
If you have a cash account, you can:
- Buy stocks, bonds, mutual funds, ETFs, and other types of securities, provided you have sufficient funds available
- Sell any securities you fully own without restrictions
- Receive dividend payments from owned securities
- Withdraw your cash at any time, provided it isn’t tied up in any unsettled transaction
- Reinvest funds from settled trades into other securities
Pros and cons of using a cash account
Using a cash account comes with both benefits and limitations. I’t's important to be aware of both the pros and cons of this kind of investment account to determine if it’s the right fit for you.
Benefits of a cash account
Let’s first explore the benefits, which include:
- Improved safety and security of funds with a reduced risk of overextending finances or accruing debt
- No risk of margin calls, where an investor must deposit additional funds to cover losses
- Lower ongoing costs compared to margin accounts, and no interest charges since no borrowing is involved
- Full ownership of any securities purchases
- Reduced emotional stress as there is no pressure of amplified losses
- Fewer regulatory requirements making compliance more simple
- Better discipline for beginner investors, helping to avoid impulsive or high-risk trading behaviors
- No risk of free-riding violations, as this is prohibited with a cash account
- High transparency with no hidden charges related to borrowing or maintaining the account
Limitations of a cash account
Of course, using a cash account comes with a few cons as well.
These include:
- Limited purchasing power as you’re only able to trade with the cash you have available in your account
- You’re unable to amplify potential returns through leverage
- The T+2 settlement requirement means trades must settle before proceeds can be used for new trades, which can potentially delay reinvestment opportunities
- Cash accounts don’t permit short-selling
- Lack of advanced trading strategies
Opening a cash account
Opening a cash account is super simple. Since it doesn't involve any borrowing or complex trading strategies, the requirements and processes involved are generally relatively light.
Requirements to open a cash account
The exact requirements to open a cash account differ between brokerages. However, most have some combination of the following requirements:
- Minimum age. You must meet the minimum age requirement in your jurisdiction.
- Identification. You must have a valid form of government-issued identification.
- Residency. You’ll need to provide proof of residency in the country where the brokerage operates.
- Initial deposit. Many brokers require a minimum deposit to open a cash account, though this is often quite low.
- Bank account link. You’ll generally need to link an existing bank account to transfer funds to and from the cash account.
Documentation needed
To open a cash account, you’ll need the following documentation:
- Personal identification. A passport, driver’s license, or national ID card.
- Proof of address. A recent utility bill, lease agreement, or bank statement that shows your name and address.
- Tax ID number. A Social Security Number (SSN) in the U.S. or another tax ID number depending on your country.
- Employment information. Some brokers may require information about your employer or income.
- Brokerage application form. A completed application form, often done online, which includes personal information and details about your financial goals
Benefits of integrating a cash account with accounting software
Thinking of opening a cash account? Then you’d be smart to choose one that integrates smoothly with your accounting platform to take advantage of:
- Real time financial insights
- Reduced data entry errors
- Improved budgeting and forecasting
- Streamlined reconciliation
- Simplified tax preparation
- Better cash flow management
BILL, our financial operations platform, integrates with dozens of popular tools. Check out our integrations here.
