When you open a brokerage account, you generally have the option of opening a cash account or a margin account.
One significant difference between these two account types is your ability to borrow funds from your broker to buy securities. With a margin account, you can; with a cash account, you cannot.
The name "cash account" causes some confusion for investors, who think only cash can be held in the account. Both cash accounts and margin accounts can hold a wide range of stock, bonds, funds, and other securities—as well as cash. For example, you might have $5,000 in cash and $10,000 in stock in your cash account.
With a cash account, the most important thing to know is that you are expected to pay the full amount for those securities by the settlement date—which, for most securities, means paying for them two days after you place an order to buy.
There are also other rules relating to cash accounts. Notably, they are subject to the Federal Reserve Board's Regulation T (Reg T). Reg T governs how you, the investor, use your cash account to purchase securities. Importantly, under Reg T, you can buy securities in a cash account provided you have sufficient funds in the account, or if your brokerage firm accepts in good faith that you will promptly make full cash payment for the security. Your brokerage firm must comply with Reg T and can take action, such as putting restrictions on your ability to trade, if it determines you incur a Reg T violation.
To avoid Reg T violations, here are some important things you need to know about a cash account.
- You must use settled funds to buy securities in a cash account. Cash or the sales proceeds of fully paid for securities constitute "settled funds."
Find examples of permissible cash account trading in the SEC's Bulletin Trading in Cash Accounts.
- You can't "freeride." This happens when you buy securities and then pay for them using the proceeds from a sale of the same securities. In a cash account, you must pay for a security in full before selling it.
- You can't borrow funds from your brokerage firm to pay for transactions in the cash account. If you intend to trade using borrowed funds, you must open a margin account to trade.
- You can't sell short. You can only sell a security in a cash account if the security is held in the account, or your broker accepts in good faith a representation that you own the security (and have paid for it in full)—and that it will be promptly deposited in your cash account.
If you have a brokerage account, but aren't sure which type of account you have—a cash account, margin account or both types of accounts—contact your firm. Firm websites often explain what you can and cannot do in a given account.
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