Margin Loans and Purchased Money Market Funds

Because a money market fund can seem much like cash in a checking account, it's commonly assumed that purchased money market funds (PMMFs) in a brokerage account get treated the same as cash in terms of margin loans. But they don't. 

Brokerages do use PMMFs to calculate margin requirements—the same as any asset—but because PMMFs are investments that investors choose to buy, they don't automatically offset margin loans and brokerages won't automatically liquidate them to prevent a margin call. On the other hand, an investor liquidating PMMFs will automatically pay down a margin loan. (Note: Automatic "sweep" programs that move uninvested cash into interest-bearing accounts differ from PMMFs. Sweep balances are treated as cash and do automatically reduce margin loans.) 

Assuming that PMMFs in a brokerage account are treated the same as cash can lead to an unexpected margin loan and interest payments on that loan, not to mention surprise margin calls. 

A margin loan is a loan from a brokerage that's secured by the assets (cash and securities) in an investor's brokerage account. It can be used to increase buying power to purchase more securities or for other short-term financial needs. In exchange, the brokerage charges interest on the loan. 

There are two types of margin requirements: 

• Initial margin requirement: The minimum amount of equity (cash and/or securities) an investor must have in their account to buy a certain value of securities on margin. For example, a 50% initial margin requirement means an investor must have at least $100,000 in equity to buy $200,000 worth of stock.
• Maintenance requirement: The minimum level of equity investors must maintain in their account after the initial purchase to continue to hold $200,000 of stock using the margin loan. 

Let's say an investor has $100,000 in cash in a margin-approved account with a brokerage that has an initial margin requirement of 50% and a maintenance margin requirement of 30%, both common thresholds for buying stocks on margin. 

In this scenario, the investor: 

• Can buy up to $200,000 of stocks ($100,000 in cash = 50% of the value of the securities purchased, the initial margin requirement).
• Must maintain an equity value in the account of at least 30% of all purchased securities (Equity = Total market value of all assets held – Value of the margin loan).
• Must add cash to the account or sell shares to maintain the 30% equity ratio, if necessary. 

Maintenance margin can get tricky because it involves moving targets. Continuing the example above, let's look at what would happen if the value of the stocks held in the account fell from $200,000 to $140,000: 

• The equity value of the account would drop to $40,000 ($140,000 in total assets held –$100,000 margin loan = $40,000 equity). That's only 28.6% of the value of the account's invested holdings of $140,000, placing it below the maintenance requirement of 30%.
• The investor would face a margin call—a formal notification from the brokerage to meet the 30% maintenance requirement.
• The brokerage would inform the investor that they needed to deposit at least $2,000 in cash or sell $6,667 worth of stock to reduce the size of the loan within a certain time period. Either move would bring the account's equity value back to 30% of its invested holdings, or $42,000.
• If the investor doesn't meet the margin requirement in the allotted time, the brokerage usually liquidates assets as needed at its own discretion. 

It's in the brokerage's best interest to keep investors informed about their margin levels. To do so, brokerages publish their margin rates and requirements on their websites and trading platforms, show key balances in customers' account details, and send alerts to investors if they approach any maintenance margin limit. And as long as the investor meets the maintenance requirements, the brokerage won't need to make a margin call, much less liquidate any assets. 

For margin, brokerages treat PMMFs much like cash—but not exactly like cash. For one, the value of any PMMFs held in the account can be used to meet any initial margin requirements, although the equity-buying power ratio varies by brokerage. And both cash and PMMFs count toward the total value of assets held in the account when calculating account equity for the purposes of setting maintenance margin requirements. 

But because PMMFs are purchased investments, brokerages won't automatically sell them to prevent the creation of margin loans. For example, if an account is approved for margin trading, and some of the assets in the account are invested in PMMFs, it's possible the account owner could unwittingly take out a margin loan by purchasing another asset of more value than the remaining cash in the account. 

Let's look at an example:  

• A trader has $10,000 in a brokerage account and parks it in PMMFs.
• Then they see a stock they like and buy $10,000 worth.
• The brokerage will execute the stock purchase but treat it as a margin trade, leaving the original $10,000 in PMMFs.
• The trader now has a $10,000 margin loan for which they'll be charged interest. 

Brokerages also treat cash and PMMFs differently when it comes to meeting maintenance margin requirements after an account falls below the required threshold. 

Cash automatically reduces the size of a margin loan. Whether from an external account or from liquidated positions, as soon as cash hits a brokerage account, the size of the margin loan drops by an equivalent amount. For example, if an investor holds a $50,000 margin loan and deposits $20,000 in cash, their loan balance would instantly drop to $30,000, and they'd only pay interest on the remaining $30,000. 

PMMFs are different. When an investor buys a money market fund, they're making a deliberate investment decision, just as they do with stocks, bonds, and exchange-traded funds (ETFs). And brokerages treat PMMFs just as they do stocks, bonds, or ETFs, meaning they won't automatically sell them to meet those margin requirements. (The brokerage may sell PMMFs if an investor cannot meet a margin call in the specified time frame. In that case, a brokerage has the right to liquidate any securities in an investor's account to bring it back into compliance with the margin requirements. This could include PMMFs.) 

Let's return to the investor who bought $200,000 in stock with $100,000 in cash. Let's say this investor sold $50,000 those equities and then bought $50,000 of PMMFs (for the sake of illustration, we'll keep the stock prices unchanged). Their account balance would look like this: 

• $150,000 in stock
• $50,000 in PMMFs
• $200,000 in total assets
• $100,000 margin loan
• $100,000 in equity  

The equity in the account is 50% of total assets, well above the maintenance margin requirement. But then the stock's price drops 50%. The account balances would look like this: 

• $75,000 in stock
• $50,000 in PMMFs (unchanged)
• $125,000 in total assets
• $100,000 margin loan (unchanged)
• $25,000 in equity ($125,000 in total assets – $100,000 margin loan) 

Now the equity in the account is only 20% of the total assets, below the 30% maintenance margin requirement, triggering a margin call from the brokerage. The investor must then return the equity to 30% in one of two ways: 

1. Deposit $12,500 in cash. This would raise equity to $37,500—30% of $125,000—and reduce the margin loan to $87,500. 

2. Sell $41,667 of securities. Once the sale is processed, the proceeds will automatically pay down the margin loan from $100,000 to $58,333 while reducing total assets from $125,000 to $83,333. Equity would remain at $25,000, but that would represent 30% of the reduced asset base, meeting the maintenance margin requirement. 

In the second scenario, selling $41,667 of the $50,000 in PMMFs would have the same effect as selling $41,667 in stocks. The key point is that PMMFs don't count as cash and the brokerage won't automatically sell the required amount of PMMFs to prevent a margin call. 

PMMFs aren't automatically converted to cash to prevent an investor from buying on margin, and brokerages won't automatically use to pay down a margin loan or reduce the total asset base to prevent a margin call. That's because PMMFs are an investment holding that brokerages treat the same way they treat other investable assets like ETFs or bonds. It's up to the investors to monitor their equity levels and margin requirements and, if necessary, liquidate any PMMF holdings as needed. Otherwise, they may face an unexpected margin loan and interest charges.