April 24, 2008 in Investing

Cash sweep: battleground for yield

When the stock market is in bull mode, it’s easy to pay scant attention to how much the excess cash in your brokerage account is earning. Perhaps not until the market goes south and cash becomes a safe haven will you care that your stingy yield is being annihilated by inflation.

Bankrate’s exclusive Cash Sweeps Study shows that billions of dollars in retail brokerage accounts are earning paltry sums for customers. Of the 20 institutions surveyed, only four automatically sweep customers’ excess cash into higher-yielding money market mutual funds. The result is that brokerages are able to borrow billions from customers while paying little more than 0.5 percent interest.

Excess cash in a brokerage account may be generated by the addition of dividends or interest, or the sale of equities or bonds. Traditionally, this money will be reinvested, but while it’s waiting to be redeployed, it should be earning as much interest as possible.

Instead, most brokerages in our survey sweep the money into FDIC-insured deposit accounts at banks that sometimes are subsidiaries or affiliates of the brokerage. The average annual yield paid on amounts up to $100,000 is 0.56 percent in these cash accounts, according to Bankrate’s survey. Compare that with the average 2.78 percent paid by the four institutions — Banc of America, Muriel Siebert, ShareBuilder and Vanguard — that automatically sweep your excess cash into a money market mutual fund even if your balance is as low as $1.

“Our products and services are designed to provide our clients with the best possible value, which includes convenience and service, as well as superior features and functionality through our online banking and investment services,” says Neal Wolfson, Bank of America product executive.

That 0.56 percent average paid by 16 institutions is padded by two brokerages, A.G. Edwards and TradeKing, which sweep money into cash accounts but pay significantly better interest than the others. TradeKing, at the time of the survey, paid a 1.12 percent annual percentage yield, or APY, on balances up to $49,999. A.G. Edwards paid a respectable 2.02 percent on similar balances.

Peter Crane, president and publisher of Money Fund Intelligence, says that it will be interesting to see how well A.G. Edwards’ rates hold up as it has merged with Wachovia, which pays 0.45 percent on balances up to $99,999. (A.G. Edwards is now Wachovia Securities but, as of this survey, separate account information was still being maintained.)

Unfortunately, it’s common to see even lower yields than Wachovia’s. E-Trade pays 0.05 percent on balances up to $4,999. TD Ameritrade pays that amount on balances up to $24,999. Wells Fargo’s WellsTrade pays 0.2 percent on balances up to $99,999.

Customer must take action

To be sure, there is no obligation on the part of brokerages to pay any interest on cash that’s sitting in an account waiting for the customer’s directive on how it should be used. Somewhere in the account-opening paperwork you received, or that was made available to you online, are the details of how excess cash will be handled. Generally, it’s up to the customer to protect his or her own interests in this regard.

“(People) don’t come to us because we pay great cash rates, they come to us because we have a phenomenal platform for them to invest and trade on,” says James Powell, managing director of treasury group at TD Ameritrade. “We have found that customers value cash from two perspectives. There’s a segment of customers that looks at rates and says, ‘My cash is worth a certain amount of rate.’ And there are some customers who look at cash and say, ‘I just want my cash to be accessible, extremely liquid, and I want it to buy these services.'”

Although only four of the 20 surveyed institutions automatically sweep excess cash into higher-yielding money funds, 14 of the remaining firms make specific money funds available to customers who request that their excess cash be swept into a higher-yielding alternative to a bank deposit account. Most of those funds require a minimum initial investment of $500 to $5,000, but some require considerably more; such as TD Ameritrade’s $50,000 minimum for its Money Market Portfolio Fund. Charles Schwab and Smith Barney have very high thresholds, $500,000 and $250,000, respectively, for requesting money to be automatically swept into money funds, but that minimum includes all household assets held at the firms.

Two institutions, Merrill Lynch and Scottrade, make no provisions for customers to request that excess cash be swept automatically into money funds. If that’s the case with your account, buy shares of a money market fund on your own when you have sufficient cash.

What’s the expense ratio?

Whether your money is swept automatically into a fund or you have to choose one manually, pay attention to the expense ratio. Money Fund Intelligence lists the average expense ratio for a top-yielding prime money fund at 0.35 percent. ShareBuilder, which gets a pat on the back for automatically sweeping cash into a money market fund, tarnishes that shine by using one with an expense ratio of 0.9 percent. Compare Vanguard, which also automatically sweeps cash into a money fund, but charges only 0.24 percent. To top it off, Vanguard’s yield is more than 0.5 percent higher than ShareBuilder’s.

In truth, none of this is too troublesome for money-conscious consumers who pay attention to how their accounts are handled. Just as with most financial products, customers need to fend for themselves by reading the literature and making smart decisions.

Class-action suit filed

But some customers say they’ve been duped by some of the institutions into putting their excess cash into bank deposit products instead of money market funds. The result is a class-action lawsuit claiming not only that the institutions are using billions of dollars in clients’ money without paying a fair interest rate, but also that the tiered structure in the bank deposit programs takes unfair advantage of clients with lesser amounts of money.

“One of the arguments we make is that these main firms really promote themselves these days as being financial advisers,” says Joel Laitman, partner at the New York law firm of Schoengold Sporn Laitman & Lometti. “They’re misleading their clients and they never disclose to their clients in a meaningful way that they’re being financially injured and that these firms are making immense profits at their own clients’ expense.”

For more on this story, and to see if your investment firm is accused of this practice, read the Bankrate feature, ” Cash sweep account controversy spurs lawsuit.”

Whether you’re a do-it-yourselfer when it comes to investments or you have someone else handle it for you, it pays to be on your guard. Know how your cash is invested, whether it’s waiting to be deployed in the stock or bond markets or if it will be sitting in your account as cash for a prolonged period.

Some people may not care what their cash is earning when the rest of their portfolio is doing well, but they should. Cash is still king.