A recent WSJ article by Jason Zweig calls attention to one of the hidden ways that brokerage firms make money from you. As interest rates rise, they go out and earn the highest market rates while giving you a lot less on your idle cash. The difference adds up to big profits.
Brokerage accounts used to make you buy a money market fund with a high expense ratio. These days, they use a “bank sweep” account. They advertise the FDIC insurance, but hide the fact that they often own the bank and are skimming millions in interest:
In a bank sweep, your brokerage automatically rakes together and deposits your spare cash in one or more banks. Banks hand the brokerage a hefty fee, and the brokerage hands you some crumbs. For any given investor, a few dollars from dividends or interest income don’t amount to much. Rolled together with idle cash from thousands of other investors, they can add up to millions.
Morgan Stanley. Ameriprise. E-Trade. If you dig through Schwab’s disclosure, you’ll see them state that “In setting interest rates, the affiliated banks may seek to pay as low a rate as possible”. Nice.
Default options often prey on your inattention and laziness. Here are some ways to avoid the low interest rates of the bank sweep accounts.
- Explore all your sweep options. Some places give you multiple alternatives for your cash sweep. For example, Fidelity has Fidelity Government Money Market Fund (SPAXX), Fidelity Treasury Fund (FZFXX), and FCASH. The two funds have SEC yields over 1.5% right now, while FCASH earns only 0.25% on balances under $100,000.
- Keep your cash accounts empty automatically. You can set up automatic dividend reinvestment, or perhaps an automatic deposit of dividends into a high yield savings account. That should keep most of your interest and dividends from piling up as cash.
- Manually reinvest often or transfer to alternative funds. Keep an eye on your cash balance, and invest it as soon as possible into stocks, bonds, or a higher-yielding money market fund alternative. Some accounts offer a text alert if you balance exceeds a certain amount like $1,000.
- Move your assets to another firm. Vanguard still has a decent sweep option (VMMXX, see below). Fidelity still has two decent money market sweep options as well (SPAXX and FZFXX).
Vanguard isn’t incentivized to play these interest-skimming games. Vanguard’s only sweep account nowadays is the Vanguard Federal Money Market fund due to new regulations (read more here). Vanguard used to have better options as the default account, but at least the Vanguard Federal Money Market fund still earns a decent SEC yield of 1.87% (as of 8/8/18). If you want, you can still move money manually into the Vanguard Prime Money Market fund, Vanguard Municipal Money Market funds, and the Vanguard Treasury Money Market fund which may do better on an after-tax basis.
On the flip side, if you are individual stock investor, this is why higher interest rates are good for brokerage firms like Schwab. If you believe in the future of low-cost index funds, Fidelity and Vanguard are not publicly-traded, but you can become a shareholder in Schwab. Heck, Schwab has even set up their “free” robo-advisor to profit from higher interest rates due to a sizable cash allocation. (I do not hold Schwab stock at the time of this writing, but it is on my watchlist.)
Bottom line. Check the interest rate on your brokerage sweep account – It might be a lot lower than you think. Consider taking action.
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