All about cash and margin trading accounts
In investing, there are a lot of choices to make – how to invest, what to invest in, and who to invest with. There’s also a seemingly endless array of account types. Confused? We’ve got you. In this article, we’ll walk you through:
- Registered versus non-registered accounts
- An overview of cash and margin account types and their purpose
- Risks associated with margin accounts
- Tips on how to choose the right account for you
What kinds of investing accounts are available?
In investing, there is a wide range of account types to suit your individual needs. There are two main categories of accounts:
- Non-registered accounts (also referred to as “trading accounts”)
- Registered accounts
A non-registered account is one in which your investment earnings (interest, dividends and capital gains) are taxable. These accounts have no restrictions on contribution amounts or tax limits (unlike registered accounts), which means you can freely move money in and out of an account without worrying about contribution limits or withholding tax on withdrawals.
At Qtrade Direct Investing®, non-registered accounts are available as individual or joint accounts, and in U.S. or Canadian currencies. Non-registered account types are:
- A cash account is a general-purpose trading account that allows you to buy and sell stocks, bonds, mutual funds, exchange-traded funds (ETFs) and a range of other investments.
- A margin account is a trading account that allows you to borrow funds from your broker using cash and securities in your account as collateral for the loan. Because margin trading comes with more risk, this type of account is suited to more experienced investors.
A registered account is one that is registered with the Canadian government and provides some sort of government tax incentive that is designed to encourage Canadians to save. These include registered retirement savings plans (RRSPs), tax-free savings accounts (TFSAs) and registered education savings plans (RESPs), to name a few. Learn more about registered accounts.
What is a cash account?
A cash account is a straightforward, low-cost investment and trading account that allows you to buy and sell stocks, mutual funds and ETFs, as well as corporate and government bonds and other fixed income investments.
Cash accounts are available in the following types:
- religious organization
- investment club
What is a margin account?
Margin trading is the practice of borrowing money from a brokerage to trade in stocks or other types of securities. Stocks held in your account are used as collateral for the loan, and the brokerage charges interest for the duration of the loan. In the investment world, buying stocks using borrowed money is known as trading “on margin.”
When the price of a stock is rising, trading on margin allows investors to use leverage to increase their gains. However, when stock prices fall, losses mount much more quickly.
In order to trade on margin, you need to open a margin account. You can’t trade on margin within a cash account or within a registered account such as a TFSA, RRSP or RESP. When you open a margin account, you start by depositing a minimum amount of cash or margin-eligible securities. Your broker will lend you a portion of the market value of those assets, which act as collateral to secure the loan. The brokerage charges interest on the borrowed funds as long as the loan is outstanding.
People most commonly borrow on margin in order to purchase stocks, but other securities can also be purchased, including ETFs, mutual funds, bonds and options. You can also use a margin account to short sell stocks.
The risks of margin trading
Buying securities on margin can increase your potential returns, but it can also amplify your potential losses. Let’s look at a few possible scenarios to illustrate potential investment outcomes.
Let’s say you’ve been following XYZ Inc. and you believe its market value is likely to increase. The company’s stock currently trades at $50 per share. You’d like to buy 100 shares, but you only have $3,000 available to invest. You could simply buy 60 shares, but you decide to borrow $2,000 from your broker on margin, and you purchase 100 shares for a total of $5,000.
If the stock price rises. If the value of XYZ’s stock goes up to $60 per share, your position is worth $6,000, while your margin loan is $2,000. If you sell that position, and pay off your margin loan, you’ll have $4,000. You started with $3,000, so you’re up $1,000, or 33%. (If you had only purchased 60 shares, and sold them at $60, you would have $3,600, a 20% gain.)
If the stock price falls. Imagine that shares of XYZ fall to $45. The market value of your position will be $4,500. You’ve invested your $3,000 principal, and borrowed $2,000, so if you pay off your margin loan, your equity falls to only $2,500. You’re down $500 and you’re still accruing interest on your $2,000 loan.
Worst case scenario. If the price of your stock plummets drastically, you can end up with a margin loan that exceeds the market value of the stock. Even selling all the stock wouldn’t raise enough to repay the loan. Regardless of how much the value of your securities declines, you are still responsible for repaying the loan. Buying on margin can be a double-edged sword: it can increase gains on the upside, but it can also amplify your losses on the downside.
If you decide to buy on margin, it’s best to take a careful, disciplined approach. Margin trading entails additional risks associated with market volatility, and requires a high level of attention, perhaps even monitoring stock prices daily.
Which account should I start with?
Which account(s) you choose depends entirely on your investing needs. Because of their tax benefits, many investors begin with registered accounts and add other accounts as their needs expand or change. It’s okay to have more than one account!
With respect to non-registered accounts, if you’re a relatively new or inexperienced investor, a cash account will be most appropriate for your everyday trading and investing needs. Because of their additional risk exposure, margin accounts should only be opened by more advanced, experienced investors. Note: To open a margin account, there are additional disclosures and terms and conditions to review.
- If you’re investing shorter term, you’ll likely need to use a cash account (or TFSA if you have contribution room).
- If you want to be able to offset capital gains with capital losses, you’ll need a cash or margin account.
- If you’re an experienced investor who wants to purchase securities on margin, trade options or short sell stocks, you’ll need a margin account.
Once you’ve decided which account is best for you, it’s easy to open an account at Qtrade Direct Investing.
The information contained in this article was obtained from sources believed to be reliable; however, we cannot guarantee that it is accurate or complete. This material is for informational and educational purposes and it is not intended to provide specific advice including, without limitation, investment, financial, tax or similar matters.
Using borrowed money to finance the purchase of securities involves greater risk than purchasing using cash resources only. If you borrow money to purchase securities, your responsibility to repay the loan and pay interest as required by its terms remains the same even if the value of the securities purchased declines.