Types of Accounts
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This article is from the What Every Investor Should Know.
Types of Accounts
Generally, there are two ways to purchase securities -- through a cash account or through a margin account. With a cash account, the investor must pay the purchase price in cash no later than the settlement date (usually within five business days of the trade). In a margin account purchase, the investor pays for part of the cost and the broker lends the remaining amount. An investor opening a margin account signs a "margin agreement" which is basically a credit or loan agreement. This document states the annual rate of interest, its method of computation, and specific conditions under which interest rates can be charged. Interest is usually computed daily on an annual percentage rate basis.
The Federal Reserve Board sets rules specifying the minimum percentage of the purchase price which a margin customer must pay in cash. Currently, the requirement is for at least 50 percent of the current market value of the security. Some brokers require higher levels, and some securities may not be purchased on margin.
Buying on margin can provide investors with a means to increase "leverage" and therefore maximize profits. However, a decline in value of securities purchased on margin could cause severe losses to the investor. The margin account agreement specifies that if an investor does not maintain a certain level of margin, generally called maintenance margin, the broker-dealer may sell securities in the account to make up any shortfall. Moreover, it is not unusual for an entire margin account to be liquidated at a substantial loss because the securities in the account declined in value. Therefore, the investor must carefully and continually monitor the value of securities purchased on margin.
A discretionary account is one in which the investor gives the broker written permission to buy and sell securities selected by the broker, at a price and at a time the broker believes to be best. The broker is not obligated to consult with the customer but uses discretion based on, among other things, knowledge of the customer and market conditions. Accordingly, discretionary authority should be granted with special care.
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