The Smart Money Move That Has People Ditching Their Bank Accounts

More people are moving their day-to-day banking into their brokerage accounts to get a better return on their cash. This is because the typical checking account pays so little interest.

According to a spokeswoman from Fidelity, the nation's largest 401(k) plan provider, there has been a double-digit percent increase in the number of people using cash-management accounts over the last three years. These money-market accounts let customers earn competitive interest on their cash without sacrificing many of the key features of traditional banking.

Charles Schwab Corporation (SCHW) is an American financial services company with headquarters in San Francisco, California. It was founded in 1971 by Charles R. Schwab, and offers a wide range of financial services, including brokerage and banking services.

Robinhood Markets Inc. is a financial services company that offers commission-free trading of stocks, options, and cryptocurrencies. The company was founded in 2013 and is headquartered in Menlo Park, California.

Wealthfront and other companies offer similar accounts.

Some money-market accounts currently offer interest rates as high as 3.8% per year, which is comparable to some high-yielding savings accounts. These accounts typically invest in short-term debt securities, such as Treasury bills and commercial paper. Like checking accounts, money-market accounts usually offer direct deposit, debit cards, bill payment, and paper checks.

As of the end of last year, traditional checking accounts paid an average of 0.05%. With inflation running at more than 6% over the last 12 months, this means that cash sitting in checking accounts is losing purchasing power every day.

Investors have added about $135 billion to global money-market funds over the four weeks ending Jan. 18, according to financial data provider EPFR. This is one way that investors have moved to higher-yield accounts. EPFR tracks fund flows from institutional and individual investors.

Jamal Carnette, a financial analyst in Dumfries, Va., said he and his wife rarely paid attention to fluctuations in interest rate on their joint bank accounts at their local credit union, which they used mainly to cover household expenses. However, they have been more mindful of their spending and saving habits since the pandemic began.

In December, Mr. Carnette realized that the interest rate on his Fidelity account was much higher than the rates on his checking and savings accounts. He decided to move most of his balances to the brokerage account in order to get better interest rates.

He said that the difference became too large for them to ignore and since then, he has withdrawn most of the cash from the credit union to sit in his brokerage account and collect interest.

Investors have been moving away from holding large cash balances in recent years, as low interest rates and lackluster returns on money-market funds have made this strategy less attractive.

As interest rates have risen, driven by the Federal Reserve’s efforts to control inflation, money markets have become more attractive to investors and consumers have become more interested in shopping for the best rates. Wealthier customers are among those who have moved their cash to get a higher return.

Despite the potential benefits, not everyone is moving their money to accounts with higher yields. Many Americans have missed out on billions of dollars in potential interest by keeping their money in low-interest bank accounts.

Brokerage accounts are not as practical as bank accounts for replacing bank accounts because of restrictions, such as transaction limits. Some limitations still exist, advisers say, including the ability to make cash deposits. Fees for money-market accounts have also increased in the past year after being reduced while interest rates were near zero.

While brokerage accounts are a great way to invest your money, they are not designed to replace traditional checking accounts. There are advantages to keeping your cash and investing accounts separate, financial advisers said. This way, you can better manage your finances and make sure your money is working for you in the best way possible.

"If you find that you're constantly transferring money between different accounts, it's probably not the best idea," said Chelsea Ransom-Cooper, head of wealth management and financial planning at Zenith Wealth Partners.

She advises clients to keep separate accounts for spending, saving and investing, to limit the chance of overspending or taking on too much risk. This way, you can better monitor your spending and make sure you're not putting too much of your money at risk.

"You don't want to put yourself in a position where you overspend and have to sell assets from your investment portfolio to cover expenses," she said. "That would defeat the purpose of being invested."

According to Gary Schatsky, a fee-only adviser and president of ObjectiveAdvice.com in New York, keeping cash in a brokerage account is an improvement over earning negligible interest in a checking account.

"While it's better than 0.3 or 0.4%, it still raises the question of what else you might be missing," said Mr. Schatsky. He added that there are likely higher yield options available for those who are willing to shop around.

According to Mr. Carnette, keeping cash in brokerage accounts is an easy way to benefit from rising interest rates without actively managing your money.

He said that he has been talking to friends and colleagues about it, which is something new for him. This is the new topic that everyone is talking about.

Those who move away from traditional banks might also benefit from higher insurance for their money.

Brokerages partner with banks that are insured by the FDIC to hold cash kept in cash-management accounts. This arrangement allows depositors to have more than $1 million in insured deposits, compared with the $250,000 maximum at individual banks.