Purchased money market funds and bank sweep accounts: Investing 101
WASHINGTON. In our previous two articles in this educational series (here and here), we examined some things a new investor should consider before actually starting to build an investment portfolio of stocks and bonds. If you’ve taken care of these items, the next thing you’ll want to do is to accumulate cash. You’ll eventually deploy that cash, little by little, into your investment portfolio. Where do you generally park the money you’re saving for investing in stocks? Answer: Purchased money market funds and brokerage house bank sweeps or bank sweep accounts.
Whatever your individual preference, I’d suggest that you accumulate roughly a minimum of $5,000 discretionary savings parked somewhere secure before you begin your investment plan. $10,000 would be better. Whatever works for you.
But let’s begin today’s installment by explaining what purchased money market funds and brokerage house bank sweep accounts actually are. En route, it would probably be a good idea to provide a little post-Great Recession history on the predecessors to these accounts. Today’s editgions are new flavors of the old money market fund sweep accounts. Unfortunately, they are a bit more cumbersome to use. Your Federal government at work.
Cash stashes today: Money market funds and brokerage house bank sweep accounts
Similar to an old-fashioned bank savings account, what I call a “cash stash” is simply a place where you deposit amount of money that you’ll ultimately deploy into the stock market.
It’s an unfortunate reality that almost all short-term investment products today carry historically miniscule rates of interest. On the other hand, new investors need to realize they must accumulate at least a modest amount of cash before they begin to pursue potentially better returns in the stock market.
That said, you still want to earn at least a pittance on your money before you re-deploy it into the market. Today’s virtual savings accounts, as offered by most brokerage houses, do include parking places like short-term certificates of deposit (CDs)—the kind where you often don’t get a penalty for early withdrawal. But they also include the money market-style products that virtually all brokerage firms offer.
Previous to the Great Recession, money market funds were the way to go for parking cash stashes of all sizes. The biggest pluses:
- Money market funds paid regular interest at decent rates that were usually better than those available at banks.
- They charged no commissions for moving in and out of them.
- And best of all, they offered virtually instant liquidity for stock trading and investing. When used for this purpose, they were also called “sweep accounts” or “sweeps.”
How brokerage house or brokerage bank sweeps work. Or used to
Prior to and during the Great Recession years, when opening a brokerage account, you usually deposited X amount of cash directly into it. This cash would go into a money market fund awaiting your first stock trade.
Pegged to close each day at the exact value of $1 per share, these money market mutual funds (that’s actually what they were and still are) would accrue interest on your daily balance and reinvest the interest, usually once a month, into more $1 shares of the fund. I.e., these funds earned compound interest, the magic ingredient of wealth building in capitalism. Your interest rate “floated” every day depending on prevailing short term interest rates.
If your weren’t currently investing that money, it would just sit there in your money market fund and gather a bit of interest. But if you bought a stock, the purchase amount (plus the broker’s commission) would move out of your money market account to pay for it.
On the other hand, if you sold a stock, the proceeds would go right back into your money market fund. There again it will gather interest and await deployment to fund another stock purchase.
Hence, the term, “sweep account.” If you bought a stock, the purchase price got “swept” out of your money market fund to pay for it. If you sold a stock, the sales proceeds got “swept” back into your money market account. Money was swept both ways. In other words, your money never sat around entirely idle. Your own personal capital earned at least a few pennies, even when not directly invested in stocks.
Recent changes in money market / sweep accounts due to post-Great Recession reforms
Over the last few years, for a variety of reasons going back to the Great Recession debacle, most brokerage houses quietly terminated their convenient, in-house money market-funded sweep accounts. The Federal government essentially forced them to do this, at least for “retail accounts.” Which means yours and mine, not Warren Buffett’s.
In an oversimplified nutshell, government and treasury officials decided that maintaining the old-style money market fund model was too risky for the average investor. So they made the rules for running and securing these funds onerous enough that brokerages decided to change the way they handled investor cash.
Today’s brokerage sweep mechanisms still invest the idle cash in your account. But now, they sweep it “bank sweeps” directly into “bank sweeps” or bank sweep accounts. These are the newfangled equivalent of old-fashioned bank savings accounts. The brokerage arranges this either with another bank or an in-house bank. Like my favorite line from one of those old Cheech and Chong movies, sweep accounts today “are the same, only different.”
Back to the Future?
In other words, today’s newer “bank sweep” arrangements still work like old-fashioned money market sweep accounts. Portions of your brokerage account cash stash today move right into and right out of a bank holding account as you buy or sell stocks. Functionally, the old sweep game remains essentially the same.
This new methodology is for your protection. You know this, of course, because the Federal government says so.
In summary: Today’s default brokerage sweep accounts are like the old ones. Except:
- Your bank sweep balance / idle cash is now FDIC insured. That’s because it’s sitting in an actual bank, either a brokerage house subsidiary bank or another one. Not an old-style money market fund.
- Your money still earns at least earn a teeny, tiny rate of interest, though less than it used to in pre-Great Recession money market fund sweep accounts.
- But… you can still buy money market funds if you want to.
Purchased money market funds
If that somewhat confusing development is not good enough for you, just poke around in your online brokerage account (more on that later) a bit. An increasing number of brokerages now offer “purchased money market funds.” These are, more or less, a re-creation of those old money market funds. And they do pay a notably better rate of interest than the new bank sweep accounts due to the following facts.
- They are marginally riskier, like the old money market funds they closely resemble.
- Generally, they are not “sweep accounts.”
- You move the money in these funds yourself if you need to use it to pay for a stock purchase. The money doesn’t “settle” (become available) until the next business day. (More on this later as well.) The old money market sweeps were essentially “one and done.”
- Purchased money market funds are not FDIC insured. But they are SIPIC insured. (Again, more later.)
In my own accounts I now leave X amount of money – enough to cover daily trading – in bank sweeps. Any additional un-invested fund now go into my purchased money market fund of choice. It’s more cumbersome than the older, simpler way of dealing with money market fund sweeps. But it still gets the job done. I just have to pay more attention.
The Book of Terms
You can park your investible cash a bank sweep account, a purchased money market fund, or even in short-term CDs. Brokerage firms generally offer all three. The generic term for quickly available money is “cash and cash equivalents.” These are your highly liquid investments or assets.
Next: What are brokerage houses, and which one should I choose?