Understanding Cash Accounts: Key Rules and Common Pitfalls

When you’re ready to invest in stocks, bonds, and other securities, one of your first decisions is choosing the right type of brokerage account. A cash account represents one of the two primary account structures available to most investors, alongside margin accounts. Understanding what this account type means—and the rules that govern it—can help you avoid costly mistakes.

What Is a Cash Account?

The term “cash account” creates confusion among many new investors. The name suggests that you can only hold cash in these accounts, but that’s simply not true. A cash account is a brokerage account where you must pay in full for all securities purchases using available funds, without borrowing from your broker. The account itself can hold multiple investment types: cash, stocks, bonds, mutual funds, and other securities all at once. For instance, you might maintain $5,000 in cash alongside $10,000 worth of stocks in the same cash account.

The critical distinction lies in payment terms. When you place an order to buy securities in a cash account, you commit to paying the full purchase price by the settlement date—typically two business days after your order (known as T+2). This “cash on hand” requirement is what truly defines how cash accounts function, rather than the types of assets they can hold.

How Cash Accounts Differ from Margin Accounts

The primary difference between a cash account and a margin account centers on borrowing power. In a margin account, you can borrow funds from your brokerage firm to purchase securities—essentially buying on credit. In a cash account, this option doesn’t exist. You cannot leverage borrowed money to increase your buying power. This fundamental limitation shapes every rule that applies to cash accounts.

Because cash accounts don’t involve borrowed funds, they carry fewer regulatory complexities than margin accounts. However, they’re still subject to strict federal oversight, specifically the Federal Reserve Board’s Regulation T (often called Reg T).

Essential Rules Governed by Regulation T

FINRA and the Federal Reserve Board enforce Regulation T to protect market integrity and ensure fair trading practices. Under Reg T, investors using cash accounts must follow specific guidelines. Here are the key requirements:

Use Only Settled Funds

You can only purchase securities in your cash account using “settled funds.” This includes cash you already have in the account or proceeds from the sale of securities you previously owned and paid for in full. The SEC’s guidance on cash account trading provides detailed examples of permissible transactions. Any trade must rely on money that has already cleared and is unquestionably available.

Avoid Freeriding

One common violation is called “freeriding.” This occurs when you purchase securities and then sell them before paying for the original purchase. In other words, you’re using the sale proceeds to pay for the purchase—which is prohibited. You must have the full purchase amount available before you complete any buy order.

No Borrowing Permitted

Unlike margin accounts, you cannot borrow funds from your brokerage firm to finance transactions. If you want to trade using borrowed money, you must formally open a margin account. A cash account strictly prohibits any form of broker-assisted financing.

Short Selling Is Not Allowed

You cannot sell short in a cash account. Short selling means selling a security you don’t currently own. You can only sell a security if you already own it in full and it’s available in your account. Your broker may accept your representation that you own the security outright and will deposit it promptly, but the security must ultimately be in your possession.

Common Violations to Avoid

Reg T violations carry consequences. FINRA and your brokerage firm have authority to restrict your trading activity if they determine you’ve violated these rules. These restrictions can severely limit your ability to execute trades, freeze your account, or require you to maintain higher cash reserves.

To stay compliant, maintain adequate settled funds before placing buy orders, never attempt to use sale proceeds to cover purchases, and keep clear records of which funds are available for trading. When in doubt, contact your brokerage firm’s compliance team for clarification.

Taking Action

If you’re uncertain whether your brokerage account is a cash account, margin account, or if you hold both types, reach out to your firm directly. Most brokerage websites provide clear documentation about account types and permitted activities. FINRA also offers investor resources and newsletters like The Alert Investor to help you understand your rights and responsibilities when trading. Staying informed about how your account works is the best defense against unintended violations and the trading restrictions that follow.