Cash balance interest and margin account

Abstract: This post is about how to maximize your cash balance interest earnings while waiting for an opportunity to invest the money.

Nowadays, many investors use discount brokers to purchase their stocks and ETFs. Discount brokers are great because you pay a low commission per trade, usually in the region of $3 to $7. However, the interest paid on the cash balance you keep at the discount broker is usually not competitive with what you can get from online banks. The following is a survey of the cash balance interest rate of several discount brokers:

2006-10-10-cashbalanceinterest.png

Contrast this with the 5.25% you can get from GMAC Bank or 4.5% from Presidential Bank checking (or even the 5.5% you can get from Eloan.com; however with Eloan.com, you do need to shuffle the money around since you cannot directly transfer the money into the brokerage using the strategy described below).

Many investors set up a “cash trading account” at the discount broker, transfer money into the brokerage, and then let the money sit there for a while (could be a week or several months) before investing.

For a “cash trading account”, this is necessary because the money must be in the account before any stock purchase can be made, never mind the fact that any stock trade settlement (when the payment is actually made) is actually three business days after the trade. The drawback to this is that by keeping cash at the brokerage, your money is not working as hard as it could be.

To maximize on interest earnings while waiting for the opportunity to invest, you can set up a “margin trading account” instead. This requires a minimum of $2000 in equity at most brokerages. After the account is set up, you will usually be given a purchasing power equal to the amount of equity in the account. A purchasing power of $5000 means that you can purchase stocks of up to $5000 in value without holding additional cash balance in the account.

This is great because it means that, for example, if you have $5000 in stock equity in the account, you can purchase any additional stock that you want, up to a value of $5000, without the need to hold any cash balance at the brokerage at the time when you make the purchase.

After the trade, if you transfer in the payment before the end of three business days (settlement date), you will not be charged any margin interest. Obviously for this to work, the brokerage should support a fast and free means of money transfer; any brokerage which supports the ACH network will usually work.

(A word of caution: do verify with the brokerage on when they start charging margin interest and when they credit your account with the ACH-in funds.)

Using this strategy, you can continue to have your cash earning at the high interest rates at online banks, while not losing the opportunity to invest at a time attractive to your investment goals.

Please be aware that if you do not transfer in the money before the end of the three business days, you will start accruing margin interest, and may be subject to margin calls and forced sales if the market turns south. This is certainly not a situation I have in mind when writing this post. I certainly do not advocate buying stocks on margin.


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9 Comments

  1. Rob

    Great blog! I’ve added a link to your blog on Blog of the Day under the category of Business. To view the feature of your blog, please visit http://blogoftheday.org/page/112616

    Reply
  2. indexfundfan (Post author)

    Hi Rob, Thanks for the vote! 🙂

    Reply
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  9. indexfundfan

    Related article on MoneyCentral : Don’t give your broker a free loan.

    Reply

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