Your Brokerage Account's Cash Might Cost You Hundreds Of Dollars.

Brokerage "sweep" accounts shouldn't be disregarded by savers who are reevaluating their cash options in the face of rising interest rates and recent bank failures.

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Many brokerage firms immediately transfer their clients' uninvested funds into bank deposits, which may be protected by government deposit insurance but often have yields that have remained defiantly low despite the Federal Reserve's aggressive rate hikes. For instance, sweep rates at Morgan Stanley MS, -6.44% start at 0.01% and increase to 0.5% for cash balances of $5 million and beyond, whereas the typical money markets mutual fund returns well over 4%. Money market funds invest in really high-quality, short-term loans and strive to keep their share prices at $1, although they are not FDIC insured.  

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According to Trade Algo, the yield difference between the 100 largest taxable money market funds and brokerage sweep accounts reached an all-time high of under 4 percentage points at the conclusion of February, with the money market funds yielding 4.39% on average compared to the sweep vehicles' average yield of 0.43%. When the Fed began its current campaign of rate hikes, the yield differential at year-end 2021 was just 0.01 percentage points. Due in part to investors' lack of attention to the yield and perception of these investments as very short-term parking spaces for cash, some broker firms have been able to maintain low sweep rates. The majority of cashers believe they will only be there for a few weeks, according to Peter Crane, president of Crane Data. Yet, with time, the balances add up.” 

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According to experts, investors who leave sizeable money in brokerage sweep accounts for any period of time should reevaluate their options due to the gaping yield disparity. The default sweep vehicles used by brokerage firms may be practical and frequently offer the security of FDIC protection. Then again, "it's not like they're keeping you prisoner," Crane argued. According to him, a lot of small investors have transferred their money recently from broker sweep devices to money-market funds, which has helped push money-fund assets to a record high of more than $5.3 trillion as of mid-March.

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According to Ken Tumin, senior industry analyst at LendingTree, the failure of Silicon Valley Bank SIVB and Signature Bank SBNY, -22.87% during the past week may only exacerbate a larger trend of depositors withdrawing money from lower-yielding bank deposits. As the yield discrepancies and stability worries deter savers from retaining sizable amounts in bank accounts, "there might be another motive for them to expedite moving over to T-bills and money market accounts," he added, in particular for individuals with cash holdings over the $250,000 FDIC limit.

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Examination of low brokerage sweeping rates

When the Fed started raising rates a year ago, low brokerage sweep prices were already under fire. In March 2022, Massachusetts Secretary of the State William Galvin ordered the securities division to look into the sweep account charges of brokerage firms. A dozen brokerage firms were written to, including Merrill Lynch of Bank of America BAC, -1.89% and LPL Financial LPLA, -6.11%, asking whether they intended to raise their sweep rates and how they would disclose risks and potential conflicts of interest to clients. Other questions were also raised in the letters.

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When the investigation was first announced, Galvin said in a statement that it was "simply unfair" that consumers were being asked to pay more for credit cards and loans while banks were keeping the interest rate increases that should have been earned on money under their custody instead of raising rates for people trying to keep their savings. According to a representative for Galvin, the inquiry is still ongoing. Requests for feedback from Merrill and LPL received no response.

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Sweep account rates were once more comparable with money market fund rates, but as brokerage companies switched to zero-commission trade, they have grown increasingly reliant on sweep revenues, according to Crane. In some instances, a sweep vehicle may direct deposits to a bank linked with a brokerage company, increasing earnings for the 

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Not that all sweep accounts provide meager profits, either. With the Vanguard Federal Money Market Fund, which specializes in short-term U.S. government securities and offers a seven-day yield of 4.53%, for instance, brokerage clients' unspent cash is immediately transferred.

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Vanguard is also testing a different, FDIC-insured sweep option; as of early February, it offered an APR of 3.1%. In diverse interest rate conditions, the new vehicle offers investors "additional opportunities to obtain competitive cash yield," according to a statement from Vanguard. "For their liquid funds, some investors may put the FDIC insurance ahead of other factors." 

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The default sweep vehicle for Fidelity brokerage customers is the Fidelity Government Money Market Fund, which carries a seven-day yield of 4.23%. A Treasury-focused money market mutual fund and an attention cash option known as FCASH, which does not have FDIC protection and offers a rate of 2.32% as of early February, are alternative sweep choices offered by Fidelity.

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Brokerage clients who have money transferred into bank deposit vehicles can receive much lower yields. The default sweep account at Charles Schwab SCHW, 3.93% is an FDIC-insured bank vehicle featuring a 0.45% APR for brokerage customers. Consumers can choose to place their cash in money market funds that pay a greater yield, but as money market funds don't offer automatic sweeps, those trades would need to be done manually.      

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In some situations, the bank sweep vehicle "offers yields that are up to 45 times higher than those offered by typical bank sweep choices and bank checking accounts," according to Mike Peterson, a spokesman for Schwab. According to Peterson, customers appreciate having insurance protection and easy access to their money through free debit cards, check writing, bill pay, and other options.

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A representative for Morgan Stanley remarked, "We offer several cash alternatives, both Morgan Stanley services and from 3rd parties, into which customers can choose to deploy their cash," where the sweep rate is 0.01% for funds under $500,000

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