Cash Account: Definition, Purpose, How To Open One And FAQs
Updated 16 October 2022
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Choosing an appropriate brokerage account is the first crucial step for investors who wish to buy and sell securities. A cash account is a brokerage account you can use to manage funds to buy securities. It is important to understand the working of a cash brokerage account before using it to determine if it suits your requirements.
In this article, we define a cash brokerage account, discuss how it works, explain how to open one, mention the differences between cash and margin accounts, share its benefits and provide an example along with related FAQs to help you better understand cash brokerage accounts.
What Is A Cash Account?
A cash account is a brokerage account into which you deposit funds to purchase securities. Using funds from this account, you pay the total cost of an investment. Cash brokerage accounts are a more conservative investment option as it does not allow you to short sales and buy on margin with cash brokerage accounts. Depending on the funds available, you may have limited purchasing power than with a margin account.
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Purpose Of Cash Brokerage Accounts
Cash brokerage accounts allow investors to purchase securities with cash that they own. For instance, if you deposit ₹1,000,000 into the investment account, you may purchase up to ₹1,00,000 worth of stocks. When an investor purchases more, they either deposit additional funds or sell a portion of their existing holdings. Cash brokerage accounts restrict the amount that one can invest and limit the potential for loss.
If you invest your entire ₹1,00,000 in stocks and lose most of it, you can lose no more than ₹1,00,000. Typically, companies view cash brokerage accounts as the preferred option for entry-level traders and investors.
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How To Open A Brokerage Account?
Here are the steps you can follow to open a brokerage account:
1. Choose the type of brokerage account
When selecting a broker, consider your investing style. Consider the types of assets you are comfortable trading or want to learn to trade while continuing to participate in the markets. It is also important for you to choose between a regular taxable account and an individual retirement account (IRA).
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2. Consider the features and associated costs
When selecting a broker, look for one with research and education tools that can help you grow as an investor, particularly if you are new to the market. There are both paid and free brokers available in the market. Market makers generally subsidise the free trades, which compensate the broker for order flow but do not prioritise price improvement. You can recognise them for their educational resources, user-friendliness, transparent pricing and commission structures, portfolio construction tools and research resources.
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3. Start the application process
After deciding on the brokerage firm that meets your requirements, start the application process. Regardless of the firm or account type you choose, you may require providing certain information prior to opening an account. It includes basic information about yourself and other account holders, like your social security number, date of birth, address and the nature of your employment. Brokers require collecting additional information to comply with the know your customer (KYC) rules, which aim to prevent money laundering and financial scam. It is also important for them to confirm your identity to prevent identity theft.
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4. Fund your account and start investing
To begin trading, first, deposit funds into your account. There are several options available, but linking a bank account to your brokerage account can be the simplest. You can start trading once your deposit gets credited to your new account.
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Benefits And Risks Of A Cash Brokerage Account
Cash brokerage accounts have several advantages, particularly for novice traders and investors who prefer low-risk accounts. Here are some benefits you may get from cash brokerage accounts:
Cash brokerage accounts prevent businesses from incurring substantial losses.
This type of account can limit potential losses per the company's strategy.
If securities decline in value, the company's investors can hold on to the stock and wait for it to rise in value rather than selling at a loss.
Having a cash brokerage account eliminates margin calls.
Cash brokerage account risks can be relatively low. The major risks are the fluctuating value of a currency because of economic factors such as inflation and the possibility of a company misusing funds.
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Example Of Cash Brokerage Account
Here is an example to help you better understand a cash brokerage account:
With an account balance of ₹50,000, you can purchase up to ₹50,000 in different securities. If you wish to purchase more, you can either deposit more funds into your account or sell some of your current holdings. If you sell a stock, you usually can not receive the proceeds until the trade settles in approximately two business days.
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Cash Account Vs Margin Account
Similar to the difference between using a debit card and a credit card when making purchases is the distinction between a cash and a margin account. When using a cash brokerage account, the investor has restrictions, as they can use a maximum of the available balance. In comparison, a margin account provides a line of credit that increases purchasing power but also incurs debt and interest fees.
Cash brokerage accounts limit losses to the total amount invested, making them suitable for relatively new and basic investors. Margin accounts enable higher potential returns and more complex investment strategies, such as buying on margin and short selling. Though, they also expose the investor to more risks, larger losses and higher costs.
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Frequently Asked Questions Related To The Cash Brokerage Account
Following are some FAQs related to cash brokerage accounts:
What are the cash brokerage account rules?
In a cash brokerage account, you pay a total amount for security before selling it. You can not borrow funds from the brokerage firm to pay for transactions in the cash brokerage account. If you intend to trade using borrowed funds, first, you require opening a margin account to trade.
Explain the workings of the margin account.
A margin account is a brokerage account that allows an investor to use cash or securities held in the account as collateral for a loan to receive an investment. Margin refers to borrowed funds and represents the difference between the total value of an investment and the loan amount. If the investment incurs a loss, the investor may be subject to a margin call, which necessitates the liquidation of the purchased securities.
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Which is a better brokerage account, cash or a margin account?
A margin account is beneficial for professional traders and investors who understand how to manage risk. These individuals require an understanding of how to execute trades, analyse charts, evaluate the business fundamentals and all important investing skills. These skills minimise the chances of making mistakes and ensure these professionals make prudent investments.
Cash brokerage accounts can be better for most investors, particularly those who are new to trading. The risk with a cash brokerage account is you can lose your principal, but cash brokerage account transactions are simpler, making it easier for novices to control their risks.
Define cash trading.
Cash trading is the selling and purchasing of securities with the cash available in the account, rather than from a borrowed margin or capital via a broker. The owner may retain the purchases for any duration that suits them. As there are no provided margins, these accounts are easier to open. Investors who prefer low risks may find this option suitable.
Is a cash brokerage account debit or credit account?
When you receive funds in your cash brokerage account from selling shares, it is credit. When you spend funds on investments, then it is a debit. The increase in cash is an increase in assets, so it is a credit. When there is a decrease in fixed assets, it is debit.
Is a cash brokerage account a liability?
Liability is the portion of the balance sheet that represents all the company's obligations. The accounts receivable is a current asset. Because of this, the cash balance is an asset, not a liability.
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