Don't Let Your Cash Get "Swept" Away

Make Sure Your Brokerage Cash Balances Earn A Competitive Interest Rate. Potential Savings: $50-100/year, maybe more. Difficulty Level: Low to Moderate

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In Please Don’t Trade Stocks, I discussed several reasons to avoid stock trading and invest in low-cost, passive index funds instead. Many of these reasons are well-known, but another downside of an online broker is the interest that is effectively “swept” away every day. How does this work?

If you have cash sitting in your brokerage account (not invested in stocks, mutual funds, ETFs, etc), it’s likely that your broker has “swept” that money into a bank account. This bank account generally pays extremely low rates (usually well under 1%). The broker then turns around and invests that cash in higher-yielding investments (usually 2% or higher on average), and earns the difference.

This adds up to many billions of dollars per year. Schwab alone earned $5.8 billion of “net interest revenue” in 2018, paying an average of 0.3% to customers on over $200 billion dollars of cash while earning an average of 2.6%. This was almost 60% of Schwab’s revenue, and the vast majority of its profit.[1]

If you have an online brokerage account (other than at Vanguard or Fidelity) with a cash balance, your cash may be in one of these sweep accounts. The lost interest may not seem like much, but it can actually be quite significant. If, on average, $10,000 of your account is held in cash over the course of the year, a 2% spread between what you could be earning on your cash and what you earn in the sweep account costs you $200 per year.[2]

So, what can you do? It might make sense to consider a broker that does not automatically sweep your cash into a low rate account - Vanguard and Fidelity send your cash to a short-term money market fund, paying interest far higher than the sweep accounts offered by other brokers. I prefer Vanguard because their money-market fees are far lower (0.11% versus 0.42% as of this post), but Fidelity deserves some kudos for being the first of the big for-profit brokers to do this.[3]

I hope this has been helpful. If you liked it, please share it with a friend! Also, please send me your feedback, requests, and success stories.

[1] Schwab is particularly reliant on interest income, but interest is a significant source of income for most online brokers.

[2] If, on average, 10% of your account is in cash during the year, this lost interest income is the (pre-tax) equivalent of an extra 0.2% in fees on your entire account. Considering the average passive index fund charges 0.08% in fees, you’re essentially paying 2.5x the fees of an index fund just by holding your cash in a brokerage account.

[3] One big caveat, which both Vanguard and Fidelity disclose, is that unlike cash sweep accounts, money-market funds are not FDIC-insured. But in practice losses have been very rare. The Wikipedia’s article (linked above as well) offers a nuanced and seemingly-balanced discussion.