Bank savers are on a roll these days, with many certificates of deposit, money market accounts and high-yield savings accounts offering around 5% returns due to a high-interest-rate environment.
The rush for a competitive yield has enveloped the sweep account, which has operated in a quiet, under-the-radar fashion off Wall Street’s beaten path for decades.
Sweep accounts automatically steer cash into bank or brokerage money market accounts that can earn ample interest at the close of each business day. Instead of earning zero dollars, a sweep account enables savers and investors to earn yields on funds that would otherwise lose value to inflation.
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With competitive money market rates, a sweep account offers a profitable safe haven for cash funds parked overnight. On the downside, fees may cut into those sweep account gains, and returns in money market accounts — like any asset — aren’t always consistent and depend on favorable interest rates.
Here’s a closer look at sweep accounts, how they work and whether they’re a no-brainer for income-seeking bank and brokerage investors:
— Sweep accounts explained.
— Sweep account benefits and risks.
— Sweep account management tips.
Sweep Accounts Explained
Sweep accounts automatically move, or “sweep,” any cash that exceeds the set limit in your bank or brokerage account into an investment account. They can be used for individual or business banking and brokerage customers.
“This way, your extra money earns interest and doesn’t just sit there idling,” says Dayten Rynsburger, chief revenue officer at lending platform Niche Capital. “Investors like these accounts — they think of them as ‘automated investing.'”
If your main bank or brokerage account has more cash than some set limit at the end of the day, the extra dollars are swept into a different account, such as an investment account. “The cash sits in that account, earning interest, until you decide to move the money back to the main account,” Rynsburger says. “You’ll usually be able to get a sweep account through your bank or brokerage firm, often by maintaining a certain minimum balance or signing up for a package of services.”
For example, let’s say you have a brokerage account that keeps $10,000 for trading stocks.
“Any amount above $10,000 at the end of the day automatically moves or sweeps into a different investment account, like a money market fund, where it earns interest,” Rynsburger says. “If your balance is $16,500, $6,500 gets moved and earns more money for you.”
Typically, a sweep network organization distributes business deposits across multiple banks so customers can get higher Federal Deposit Insurance Corp., or FDIC, deposit insurance coverage.
“Doing so allows depositors to get expanded deposit coverage while maintaining only one banking relationship,” says David Quinn, chief financial officer at digital banking platform Bluevine.
Most banks and brokers offer some form of cash sweep program, but they come with different labels. “You can tell cash sweep programs since they often include the terms ‘program bank’ or ‘omnibus account’ or ‘FBO’ (which stands for ‘for the benefit of’),” says Gary Zimmerman, founder and CEO at money management platform MaxMyInterest.
Do your research on the terminology your bank uses to ensure you’re getting the best deal. Several large firms have paid fines in recent years for placing their clients in sweep vehicles that don’t offer the best yield.
“Notable examples include Schwab, who paid a $187 million fine, and Voya Financial, who paid a $23 million fine for violating their fiduciary duty to clients,” Zimmerman says.
[READ: Should Investors Have Multiple Brokerage Accounts?]
Sweep Account Benefits and Risks
Benefits
Increased FDIC coverage
. Spreading your money across multiple banks gives you up to $250,000 in Federal Deposit Insurance Corp. (FDIC) coverage per bank. “When thinking about our customers, for example, many small- to medium-sized businesses have more than that amount in their accounts,” Quinn says. “Protecting as much of it as possible is just good and smart business.”
Extra peace of mind. Quinn notes that sweep accounts offer an extra layer of protection that doesn’t necessarily appear on your balance sheet.
For example, imagine two identical startups that each have $1 million in cash on their books. The only difference between the two companies is that one uses sweep accounts to hold its cash, while the other has all of its money sitting at a firm called Silicon Valley Bank. You wouldn’t know it by looking at the financials, but in March 2023, the first firm would’ve been comfortably protected from the regional banking crisis that unfolded, while the second briefly risked losing 75% of its liquid capital overnight.
Simplified banking experience. While you must give your bank authorization to activate the network, “customers can still manage funds using their primary business checking account,” Quinn adds.
Risks
Monthly fees. Monthly sweep account fees range from as low as $20 per month to $150 per month. Banks or brokerages may also take fees equal to a percentage of a customer’s total average daily deposits. Amounts may vary depending on market conditions, but they usually won’t exceed the current federal funds rate.
Returns vary. Some financial services firms offer rates that largely match the 4% to 5% offered by the best money market funds in 2024. Yet others may offer sweep returns that are well below those rate levels, with some as low as 0.001%.
It’s up to the banking or brokerage customer (or their financial advisor) to read the fine print on sweep accounts, as there are more underlying risks than customers likely know about. “For example, with a cash sweep program, depositors could be at risk in the event of bank failure,” Zimmerman says. With cash sweep programs, depositors also don’t know (or have control over) where their funds are held. “This means that if a broker sells your deposits to a bank where you already have an account, your deposits might overlap and thus might not be fully FDIC insured,” Zimmerman says.
Clients who agree to keep their cash in sweep programs may also face liquidity risk.
“If the intermediary bank were to fail or the broker-dealer’s website were to crash, the client would temporarily lose access to all of his/her funds,” Zimmerman notes. That’s because, in a brokered deposit system, funds are not held directly in the client’s name but in omnibus FBO accounts.
Consequently, if a client contacted any of the program banks to get their money back, those banks would refuse to talk to the client. “There, the client does not have a direct relationship with the banks that hold their funds,” Zimmerman adds. “In short, these program bank solutions introduce significant liquidity risk in the event of bank failure or even website outage.”
Sweep Account Management Tips
While sweep accounts may be a foreign notion to most banking or brokerage customers, they’re not difficult to manage if you do some homework. Take these tips to the table with your sweep account experience.
Sign up yourself. You can avoid sweep account risks by opening bank accounts directly in your name. “There’s no need for an intermediary or broker,” Zimmerman says. “More modern cash management solutions make it easy for clients to open multiple accounts directly at the banks of their choice by filling out a single application form.”
Watch out for minimum balance requirements. In most cases, banks or brokerage firms offer sweep accounts automatically to customers, with no specific qualifications required. “However, some institutions may have minimum balance requirements for sweep accounts or may offer them only to certain account holders, such as high-net-worth individuals or business clients,” says Michael Collins, financial planner and founder of WinCap Financial. So before you sign on the dotted line, check with the bank and brokerage websites to see if there are any minimum deposit issues.
Remember to ask. While most banks and brokerage firms offer sweep accounts, don’t assume you’ll be included automatically. “Sometimes sweep accounts are only offered to clients who specifically ask for them,” Zimmerman says.
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Sweep Accounts: What They Are and How to Open One originally appeared on usnews.com
