An investor sells a stock and decides to wait before buying anything else. The sale proceeds appear as cash inside the brokerage account. Nothing seems to be happening. Something usually is. Brokerages need a place to hold uninvested customer cash, and the way they handle it can affect the interest an investor receives. These arrangements are commonly called cash sweep programs.
What is being swept?
When cash enters a brokerage account through a deposit, dividend, interest payment, or security sale, the brokerage may automatically move that money into a designated product.
The investor might see only a simple cash balance on the screen.
Behind the scenes, the money could be placed into a bank deposit program or invested in a money market mutual fund.
The SEC has warned investors to understand their brokerage's default sweep arrangement because available options may pay very different yields.
The default option may not pay the best rate
Convenience creates inertia.
Many investors spend hours comparing expense ratios between ETFs while leaving thousands of dollars sitting indefinitely in whatever cash option their brokerage selected automatically.
Suppose one sweep earns 0.5 percent while an available alternative earns 4 percent.
On $20,000 of cash, that difference is about $700 over one year before taxes, assuming rates remain constant.
For $200 of unused cash, the difference is trivial.
For an investor holding a future home down payment or several months of portfolio proceeds, the opportunity cost can become meaningful.
Why would brokerages offer low-yield sweeps?
A brokerage may earn revenue related to customer cash.
For bank sweep programs, brokerage firms may receive compensation connected with deposits placed at participating banks.
Financial firms disclose these arrangements in account agreements and sweep-program documents.
The incentives matter because the product that is easiest for the brokerage is not necessarily the product that maximizes the customer's yield.
That does not automatically make a sweep program inappropriate.
It means investors should understand the economics.
Protection depends on the destination
Cash swept to an eligible deposit account at an FDIC-insured bank may qualify for FDIC insurance.
Coverage depends on the customer's deposits at that bank and applicable ownership rules.
Cash placed into a money market fund receives different treatment because a money market mutual fund is a security rather than a bank deposit.
That difference can matter especially when brokerage sweep networks use several partner banks.
Investors should check which banks actually receive their deposits because other money they already hold at those institutions can affect FDIC coverage calculations.
Yield can change rapidly
Cash yields respond strongly to short-term interest rates.
When central-bank policy rates are high, the difference between an efficient cash-management product and a low-paying default account can become much larger.
When rates fall, money market and savings yields typically adjust downward.
This means investors should avoid treating today's yield as permanent.
A product paying an attractive rate this month may pay considerably less next year.
Cash has a job
Investors sometimes criticize holding cash because its expected long-run return is lower than stocks.
That comparison ignores why the cash exists.
Money needed for tuition next semester should not necessarily be exposed to stock-market volatility in pursuit of a higher expected return.
Emergency savings need liquidity.
Investment cash waiting for a planned purchase may need stability.
The important question is whether the cash is being held intentionally.
Idle cash should still be earning an appropriate return for the level of safety and access the investor needs.
Check four things
When reviewing a brokerage cash position, examine the actual sweep product.
Look at its current yield.
Determine what form of protection applies.
Then find out whether a higher-paying option is available without interfering with the money's purpose.
That five-minute review can sometimes accomplish more than spending hours trying to identify the next winning stock.
Good financial management is often less exciting than investing.
It can also be surprisingly profitable.
Sources
- U.S. Securities and Exchange Commission, Investor.gov, Cash Sweep Programs for Uninvested Cash in Your Investment Accounts.
- Federal Deposit Insurance Corporation, deposit-insurance guidance.
- SEC Investor.gov, money market fund guidance.