Cash Accounts vs. Margin Accounts on Robinhood: A Comprehensive Comparison

The investing landscape has evolved over the past few years, with a noticeable surge in the number of retail investors getting their feet wet in the stock market.

Companies like Robinhood have played a significant role in this transformation, bringing Wall Street to Main Street.

Robinhood offers its users two distinct types of accounts: cash accounts and margin accounts.

Understanding the difference between these accounts is important if you've considered dipping your toes into the world of investing through Robinhood.

The Basics: Cash Accounts

A cash account is the foundation of investing — you deposit funds and use those funds to buy stocks, ETFs, or options.

Every transaction you make is fully covered by the cash you've deposited into your account. Robinhood, in line with its mission to make finance accessible to everyone, recently expanded options trading to its cash accounts, an addition eagerly anticipated by its user base. This expansion empowers advanced investors to engage in more complex strategies without worrying about how many day trades they make.

However, options trading is only suitable for some. The inherent risks associated with options trading make it necessary for interested Robinhood users to apply for access, have his or her account reviewed, and qualify before he or she can start.

The Power (and Risk) of Margin Accounts

A margin account is like a cash account — but with a twist. When you open a margin account, you are essentially borrowing money from Robinhood to purchase securities.

This borrowed money increases your purchasing power and, consequently, your potential returns. For instance, if a stock bought with a margin doubles in price, your percentage gain is double compared to if you had purchased the stock in a cash account.

However, there's a flip side to this coin. While the ability to leverage borrowed money can amplify your returns, it can also amplify your losses. If a stock price drops, your losses could surpass your initial investment. Furthermore, you would also be responsible for repaying the loan to Robinhood.

Moreover, suppose the total market value of the securities in your account falls below the maintenance margin requirement. In that case, Robinhood can issue a margin call requiring you to deposit additional funds or securities to meet the requirement. If you can't meet the margin call, Robinhood can sell your securities to recoup its loan, and it doesn't need your permission to do so.

Choosing the Right Account for You

The choice between a cash account and a margin account largely depends on your risk tolerance, financial resources, and investment objectives.

A cash account is perfect for beginners and those who prefer to invest only the money they can afford to lose. This option allows investors to navigate the financial markets without the added pressure and risk of borrowed money. This is also our favorite as a general rule.

A margin account, on the other hand, is better suited for advanced investors who are comfortable with the associated risks and costs. These investors must be ready to monitor their investments closely and respond to potential margin calls.

Before opening an account of either type, it's important to understand the differences, the risks involved, and the obligations you undertake. True to its mission, Robinhood provides extensive educational resources on its platform to assist investors in making informed decisions.

As with any form of investment, remember that all investments involve risk, and past performance is not indicative of future results. It's always advisable to consult a financial advisor or do thorough research before venturing into the world of investing. Regardless of the type of account you choose, Robinhood offers a platform that can cater to both the beginner and the seasoned investor alike.

Resources

Here are links to a few resources that may help you to better understand the risks and benefits of margin accounts on Robinhood.

• "Understanding Margin Accounts" from the U.S. Securities and Exchange Commission.
• "Trading in Cash Accounts" from the U.S. Securities and Exchange Commission.
• "What’s margin investing?" from Robinhood's support documentation.