Have you noticed any changes with your brokerage account’s “sweep” account option? Sweep accounts are set up at the time you open your account; usually there is an option to sweep money you deposit into your brokerage account into a money market mutual fund to earn interest until you decide to put that money into a trade.
Recently, money market mutual fund sweep accounts seem to be either disappearing or increasing in cost (total operating expenses), resulting in lower yields for customers. For example, a major firm’s sweep vehicles that I reviewed had what I consider to be very high costs (total operating expenses of 1% or more).
In a recent Barron’s article, “How Brokerages Use ‘Sweep Accounts’ and Cash In on Your Desire for Convenience,” Daren Fonda noted that most brokerage firms no longer provide a money market fund as the sweep account.
- “Brokers that have eliminated money markets for cash sweeps include Charles Schwab (ticker: SCHW), ETrade Financial (ETFC), Edward Jones, LPL Financial (LPLA), Bank of America Merrill Lynch (BAC), Morgan Stanley (MS), and TD Ameritrade (AMTD),” reported Fonda. “Only two holdouts — Fidelity and Vanguard — still make money markets available for daily trading and liquidity.”
Why is this happening? The low interest rate environment. Brokerage firms make money on these sweep accounts, and with yields so low, there is less money to be made.
- Here are some data points, as reported by Fonda: “The Fed’s quarter-point rate reduction on Aug. 1 sent already-low sweep yields even lower. ETrade yields dropped to 0.08% from 0.15% for cash balances between $100,000 and $250,000. Morgan Stanley trimmed rates for all accounts under $1 million. At Merrill Edge, the discount brokerage division of Bank of America Merrill Lynch, sweep yields are down to 0.05% from 0.14% on balances with less than $250,000.”
What should investors do? They can get higher yields while still investing in cash equivalents by placing trades, instead of just relying on the convenience of previously higher-yielding money market mutual fund sweep accounts. If they want access to cash from that money market mutual fund, they will have to place a sell order and wait until it settles.
Another sweep option offered by some brokerage accounts is a sweep into an FDIC-insured brokered certificate of deposit. Yields are better, but you have to be aware that some due diligence is in order.
Here’s why: FDIC insurance goes a long way to protecting against bank failures for CDs that may be in the brokerage firm’s offering. However, there are rigorous procedures that the brokerage firms must follow to claim that insurance on behalf of you (the client) should there be a failure. You are not the depositor directly. The FDIC insurance coverage “passes through” the agent or custodian (the brokerage firm) to the principal (that’s you).
There is a complication that can affect the principal’s coverage: The FDIC sorts the broker’s list against the bank’s depositor database to determine the amount of FDIC coverage.
Take this example from the FDIC’s Processing Guide: “John Doe is one of your owners/investors, and you disclose that he has $120,000 on deposit at the failed institution. John Doe also deposited $50,000 directly at the failed institution and another $125,000 through a separate broker. Our computer program will group these three accounts together and reflect that John Doe has $295,000 on deposit in the single ownership category. In accordance with the deposit insurance regulations, John is only insured for $250,000.”
Sweeps options will be developing further as we go through the low-interest-rate environment; and, in fact, yields could go negative at some point. As things change, I’ll keep you informed in this column. To read more about FDIC requirements, go to fdic.gov/ deposit/deposits/brokers/index.html.