Reviewed by Thomas J. Catalano
Online stock accounts use specific terminology that could be confusing to a novice trader. Three terms that every newcomer should know are account value, cash value, and purchasing power. These are the three types of value that every brokerage trading account has. While they are related to each other, each term means something slightly different and has different implications for your investments.
Online brokers and brokerage firms are highly popular these days because they offer secure interfaces that allow fast trading, trend and predictive analysis, and the ability to borrow funds or trade on margin. Knowing more about how these platforms operate, including the terminology they use, will help you become a more confident and capable investor.
Key Takeaways
- Brokerage trading accounts have three types of value: account value, cash value, and purchasing power.
- The account value is the total dollar worth of all the holdings of the account.
- The cash value is the total amount of liquid cash in the account, available for immediate withdrawal or use.
- Purchasing power is the amount available to buy securities, including cash, account equity, and margin (money that can be borrowed).
- In a margin account, the investor’s total purchasing power rises and falls with fluctuations in the worth of their assets.
Account Value Definition
The account value, also known as total equity, is the total dollar value of all the holdings of the trading account. This includes cash as well as securities. The account value is the current worth of all positions in the account if they were to be liquidated at that moment.
Account value is calculated in two steps:
- Add the total amount of cash in the account and the current market value of all the securities.
- From that number, subtract the market value of any stocks that are shorted.
The final number from this calculation is the account value.
Cash Value Definition
The cash value, also referred to as the cash balance value, is the total amount of actual money in the account. Actual money is the most liquid of funds, which means the funds that are easily accessible at that moment.
This figure is the amount that is available for immediate withdrawal. It is also the total amount available to purchase securities in a cash account.
Purchasing Power Definition
The final figure, purchasing power or buying power, is the total amount available to the investor to purchase securities. This amount overlaps to some degree with cash value, but it goes further. It includes both the available cash on hand as well as any available margin.
Important
Margin is money that is borrowed from a brokerage firm to buy stocks or investments. It is the difference between the total value of securities held in the investor’s account and the loan amount from the broker. If an investor buys on margin, they are using the borrowed money to buy securities.
The purchasing power of an investor depends on the amount of equity in the account, which is the total value of the stocks and other investments held in the account minus any outstanding margin loan. Another way of thinking of this is total assets in the account minus total debts from loans. It is the buying power of an account.
Purchasing power also depends on the type of account the investor has. If the investor has a margin account, their purchasing power will almost always be greater than the cash value.
Limits on Purchasing Power
The Securities and Exchange Commission (SEC) limits the value of stocks that an investor can purchase using margin. That limit is two times the equity in the margin account. Basically, the investor can borrow 50% of the cost of stocks.
If the account is a pattern day trading account, which refers to traders or investors that execute four or more day trades during five business days, the limit increases to four times the equity in the margin account. This is for day trading only and not other types of investors.
The Risks of Buying on Margin
Like any other kind of loan or borrowing money, buying stocks on margin comes with risk.
As the stocks in a margin account increase in value, so does the account’s and the investor’s purchasing power. If the stocks go down in value, so will the purchasing power. If an investor uses their full margin purchasing power to buy stocks, they will be at twice the leverage in a margin account. Losses will be increased because of the margin loan used to buy them.
Thus, if an investor’s stocks go up by 10%, the investor gains 20% on their equity. A decline of 10% will mean a 20% loss. For day traders, the purchasing power gains and losses are multiplied by four.
What Is a Margin Loan?
Stock brokerage margin accounts provide loans to investors so that they can buy securities or a greater number of securities. The loans are called margin loans, and they increase the stock purchasing power of the investor along with the potential to make greater profits or losses on those investments.
Do You Pay Back a Margin Loan?
As with other types of loans, margin loans must be paid back with interest, and rates vary depending on your brokerage and account. This is why buying securities on margin can be risky. Even if you lose money on the investment, you still have to pay back the margin loan plus interest. If your investment positions mean you would not be able to pay back a margin call, you should not use margin to purchase new securities.
Can You Withdraw Cash From a Brokerage Account?
A brokerage account is generally a flexible investment account without withdrawal penalties. This means that any liquid funds can be withdrawn whenever you want. However, withdrawing funds may have tax implications, even if you do not have to pay any withdrawal penalties.
The Bottom Line
Brokerage trading accounts have different types of value, each of which tells you something slightly different about the assets in the account. Account value is the dollar worth of everything in the account. Cash value is the amount that is available to withdraw immediately. Purchasing power is the value that can be used to buy securities, including any available margin.
A margin account allows investors to use a loan from the brokerage to purchase securities. However, like any other loan, this comes with risks. If you would not be able to afford to pay back a margin loan, plus interest, if you lose money on a trade, you should not make use of margin to purchase securities.