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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I just keep my idle cash in GSY and MINT
With GSY / MINT expense ratio, are making less than a CD.
Liquidity at a price.
Brokers have always done this. It’s in part how they fund the departments in their companies that custody client assets–which they don’t explicitly charge for. And you’re right, you can minimize it with a little vigilance. It’s similar to the way Vanguard uses securities lending revenue to compensate for their lower expense ratios.
A journalist could easily write a similar story about how much Vanguard earns from securities lending, and I’m sure there are some huge dollar numbers there each year, and make it look like Vanguard was profiteering. But just pointing out a big number in a vacuum doesn’t always paint the entire picture.
As long as the brokers aren’t making obscene levels of total profits, and many of them are public so their profitability is widely known–and it’s a very competitive business–and you can opt out of the more egregious options, I don’t know if there is much of a story here.
My Fidelity IRA core position is in FDRXX. I can change to FDIC Insured, or SPAXX. Not sure if FDRXX is available to others.
From what I read on a review on Fidelity’s cash sweep program, FDRXX is only open for IRA accounts as a sweep option. SPAXX and FZFXX are options for retirement and non-retirement accounts.
Hi Jonathan,
I just saw your post, but haven’t looked closely into each security. Do you know if a principal fluctuates or “per share value is at $1” ?
The big risk looming in your money market fund
https://www.cnbc.com/2016/02/24/beware-you-may-lose-cash-in-your-money-market-fund.html
Typically MM are traditionally always $1 per share.
It only broke the buck once in recent years, and that was an anomaly.
As always, everything is okay until its not and by the time the average retail investor figures that out its too late. And as far as CNBC, Bloomberg and all the rest of the talking heads….its yesterdays news tomorrow and its already to late. Over a one year period, on $100K the difference between these funds and an FDIC insured Money Market is two good dinners and a movie.
Any idea how to change the sweep option in a Fidelity Brokerage account? I’m lost in the sea of links.
Are there any drawbacks to switching the sweep account from FCASH to Fidelity Government Money Market Fund (SPAXX), Fidelity Treasury Fund (FZFXX)? Do they have redemption fees?
David as far as a=I understand from my call to Vanguard, by switching you’re no longer pegged to a dollar. The principal may go down.
Thanks, Sam. I hadn’t really thought about that, but they do ‘strive’ to be a dollar value.
I talked with Fidelity: FZFXX&SPAXX both have the same liquidity as FCASH, no fees and an interest rate a little over 1%. I will take it
Thanks for article
J P Morgan is changing the sweep on about 3/2/2020 on brokerage accounts. They will no longer offer a money market mutual fund as an option for a sweep. They want it to go in their JP Morgan Chase Deposit Account which pays even less interest than the money market. The bank will then take the difference and keep it for themselves. This is how they are profiting on your money. Government needs to regulate this to force the banks to pay interest to you on your money.
On hindsight, with the pandemic emergency starting in March 2020, it pushed rates to near zero for Money Market mutual funds (almost all dropped to 0.01%) and banks. It was only the sudden surge in inflation in 2022 that has pushed Money Market fund rates to above 4%. Some banks have also raised rates to near 5% to compete, but there are still many that have stayed at 0.01%. Most brokerage bank sweep rates are below those of the Money Market mutual fund rates at this time. As for the suggestion to force banks to pay the “current prevailing rates” for deposits, they can respond by saying that the deposits are not being held hostage. The customer is free to withdraw them.