Brokerage account cash balances - Use Savings accounts and ETF funds to maximise returns
Personal_Finance / Investing Feb 15, 2007 - 03:41 AMBy: Hans_Wagner
Here is another example of how our stock brokers do not have their investors' best interest at heart. Brokerage firms have discovered that they can pay a very low rate to investors for their excess cash and then invest that cash in higher yielding alternatives. This is great for the brokers as many of them are reaping substantial profits from reinvesting their client's excess cash. Meanwhile their customers are receiving substantially less. According to a recent Wall Street Journal article “How Wall Street Sweeps the Cash,” January 7, 2007, Brokers pay as little at 1.5% when their money market funds are paying as high as 5%. Small investors are receiving the short end of the deal.
It seems that the problem is investors are more focused on where the market is going and what stocks to buy, than on where to invest their excess cash to gain a higher return. Properly investing your excess cash helps increase overall returns. Unfortunately, like so many other investing ideas, there are important issues that must be considered before committing you money.
Considerations
Just so everyone knows, the cash we are considering are the available funds in your brokerage account that has not been committed to a stock position. This cash needs to be made available on fairly short notice should you wish to make a buy. Also, investors are looking to increase the return on this cash without taking on more risk or incurring unnecessary expenses. Basically we are talking about short term investments that offer a better return than we get from the broker, yet we can access the money quickly.
The actual return will vary depending primarily on the level of short term interest rates and to a lesser extent the firm that is offering the product. Also, different products may have different fees and expenses. Money Market Funds like mutual funds charge an expense that is paid before any return is computed. Others may charge a transaction or load fee. And then your broker may charge a fee to buy and sell the product. As always it is important to read the fine print before making an investment decision.
Traders, who trade very often, need quick access to their available cash should they wish to make a trade. Investors, who are looking for good opportunities and are not trading frequently, night be able to wait a few days before deploying their cash on a trade. This is an important consideration since several of the options can take up to five days before your cash is available for investing. For example, the following statement is from a well known on line broker and is representative of the policies in place when transferring money from one account to another.
“ If the destination account is a brokerage account, you may use the funds you transfer for trading after the 5th business day from when the transfer request is received.”
Several other brokerage firms have the same or very similar policy. I did not check with every firm, so there may be a few who do not place a hold on the funds until they have “cleared.” Part of this restriction may come from a securities settlement rule commonly known as “T+3” – shortened for “trade date plus three days.” This rule means that when you buy securities, the brokerage firm must receive your payment no later than three business days after the trade is executed.
The point is you need to check with your broker to determine how long you must wait to use your funds if you transfer them from another account, either within the firm or from an outside institution. Also, keep in mind that this will impact your total purchasing power if you use margin.
ALTERNATIVES
There are basically three alternatives that are available, besides keeping the cash in the existing low rate account. These alternatives are Money Market Funds, Exchange Traded Funds (ETFs) and Direct access savings accounts. Each of these alternatives offers advantages and disadvantages.
Money Market Funds
Like any other mutual funds, a money-market fund has professional management, has some expenses, etc. The return is usually slightly more than banks pay on demand deposits, and perhaps a bit less than a bank will pay on a 6-month CD. Money-market funds invest in short-term (e.g., 30-day) securities from companies or governments that are highly liquid and low risk. As of the day of this article, the largest money market funds are paying 4.7 – 5.10 percent.
Keep in mind that your broker may charge an early redemption fee if you sell your shares in the fund before a set time period, such as 90 days. If true then you need to factor in this cost to the total return. Check with your broker to determine their policy. For some fund companies, this fee is be waived.
ETFs
There are several Exchange Traded Funds (ETFs) that seek to match a short-term U.S. Treasury market index. For example, iShares Lehman 1-3 treasury (SHY) is an ETF that seeks investment results that correspond generally to the price and yield performance of the short-term sector of the U.S. Treasury market as defined by the Lehman Brothers 1-3 Year Treasury Index. The return on these funds will closely parallel the yield on the index. The fund is yielding about 4.1% as of the date of this article, slightly less than what is available from Money Market Funds. This fund pays a divided every month. The price reflects this payment schedule as the price reflects the accrual of this payment until it is declared. Then the price falls to reflect the payment. As a result the fund tends to reflect the yield of the index.
Since ETFs are traded just like stocks, you will pay a commission to your broker when you buy the shares and when you sell the shares. These transaction costs must be included in the total cost to derive the actual return. The Exchange-Traded Funds Manual.
Direct Savings Accounts
There are a growing number of direct savings accounts offered by banks to attract deposits through the internet. These accounts are like a lot of other online savings accounts. The main attraction is the high annual percentage rate they pay. As of the date of this article several were paying 5.05% to 5.15%. You can typically earn more than brick-and-mortar banks. Furthermore, there are no fees for the service or minimum balance requirements. You can literally open an account with $1.
With these accounts, you keep your existing checking account and link it to the direct savings account. To move money back and forth, you login to your online savings account and request a transfer. These transfers are free on the online savings bank's side, however you should check with your broker to make sure they won't assess a charge. I checked with several of the banks that offer these online savings accounts and they handle transfers to and from your brokerage account.
I tested two of the most popular accounts, one from ING and the other from HSBC. I had good experiences with each and they use practically the same processes to open an account, fund the account and then make transfers. To open an account you just fill in all your personal information and wait for the bank to make some test deposits to your linked account. The process moves fast, and your initial deposit can end up earning interest within a week. Transfers were easy, though it usually took at least 3 business days for the money to be received by my brokerage account. Then the 5 day waiting period started, before I could make buys with the money. This was the most significant problem I encountered – waiting 8 days to be able to use the money for a trade.
I've found that the customer service at was pretty good. Of course this is unscientific and your results may vary. So far, I haven't encountered any long hold-times and the representatives have been knowledgeable and helpful.
Your Broker
Many brokers also offer banking services including savings accounts that can be linked to broker accounts. The rates paid on these accounts are competitive with the direct savings accounts. They also offer an online transfer service, however, in the case of my broker and that of a couple others that I checked, there is still a hold placed on the use of the funds for investing.
Also, ask your broker if you can get a higher rate on your available cash. You never know they might be able to accommodate your request. After all, there are competing products for that money and they will not like to see you move it to other products.
Suggested Approach
The table below presents a summary of the alternatives and the key considerations. Each investor should evaluate their situation. For example, if you believe you can delay an investment decision 5 to 8 days, then a Direct Savings Account might be the answer for you. On the other hand, if you are a trader, then the existing rate you receive may be the best way to go. ETFs and money market funds will likely incur commissions when you buy and when you sell, so any increase return may be consumed by these additional costs. Be sure to calculate this cost compared to the expected return before committing to this approach.
For example, let's say you have $50,000 sitting in cash waiting to be invested at 5.00% in either a Money Market Fund or Direct Savings Account. You can get 4% in an ETF. You expect to be able to leave it there for 10 days before you want to move it back to your trading account. Let's also assume you pay $10.00 for each trade. You will earn $13.79 on your cash at your trading account “sweep account,” where you are receiving 1.0%. Each of the options will beat your current broker “sweep account” return even including commissions. However the Direct savings Account and the competitive bank account from your broker tie for the best rate. Just remember these are hypothetical rates. Check with your broker and the various Direct Savings Banks to get specific rate and account information before making a commitment.
Account |
Rate |
Commissions & Fees |
Availability of Your Money |
Earned based on Assumptions |
Money Market Funds |
Competitive rate |
Depends on fund and broker. May incur commission to buy and sell. |
Depends on broker, but probably 5 business days. |
$48.49 |
Exchange Traded Funds |
Better than broker buy less than MMF and Direct Savings Accounts |
Will pay standard commission to buy and sell, just like stocks. |
Depends on your broker. May follow the T+3 rule, trade day plus 3 more days. |
$34.79 |
Direct Savings Accounts |
Competitive rate |
No commission or fees, though check with your broker. |
Depends on broker, but probably 8 business days – 3 to execute the transfer plus 5 by your broker. Remember it also takes 3 business days to transfer your money from your broker to your savings accounts. |
$68.49 |
Your Broker – Savings Account |
Low rate. |
None |
Immediate. |
|
Your broker – current brokerage account |
Can be competitive rate |
No commission or fees, though check with your broker. |
Depends on broker, but probably 5 business days. |
$68.49 |
For me, I will use one of my broker's savings account, when I believe I will not be buying anything for a couple of weeks or more. Otherwise, I will just keep pressing my broker to share some of their profits on my money.
by Hans Wagner
tradingonlinemarkets.com
My Name is Hans Wagner and as a long time investor, I was fortunate to retire at 55. I believe you can employ simple investment principles to find and evaluate companies before committing one's hard earned money. Recently, after my children and their friends graduated from college, I found my self helping them to learn about the stock market and investing in stocks. As a result I created a website that provides a growing set of information on many investing topics along with sample portfolios that consistently beat the market at http://www.tradingonlinemarkets.com/
Comments
Post Comment (Moderated)
