New York City has stringent anti-idling laws for parked vehicles. The City even pays bounties for citizens who send in video evidence of people sitting in their cars with their motors running. The spirit of the law is to prevent wasting gas and to improve community conditions.
Leaving cash in your brokerage account is akin to burning fuel without getting anywhere. It’s not productive for you or your long-term investment goals. I’m anti-idling for the long-term investor. Cash is basically a zero-expected return asset class. But the reality is that there’s always going to be some cash in your brokerage account. Cash generally comes from deposits you make, proceeds from selling your investments and dividends. And some investors simply prefer having some portion of a portfolio in the safety and surety of cash.
Making cash on your cash
Retail brokers look to help you avoid idle cash. They typically place it in some form of interest-bearing program. Pay attention to what your broker does with your cash. When you open a brokerage account, there is usually some default position, or action, for your cash.
Some brokers place your cash into money market funds, often their proprietary, in-house funds. This allows the broker to earn fees from your idle cash. Some brokers “sweep” your cash from the brokerage into a bank, typically a bank they also own (an “affiliated” bank). These deposits are often insured by the FDIC. The bank pays you some interest rate on your “sweep” deposits, and invests your cash into higher-yielding investments (usually bonds). The bank earns a “spread” on the difference between the rate it pays you on your cash deposits, and the rate it earns on the investments it makes using your cash. This is called “net interest margin” or “NIM” in industry jargon. One-year U.S. Treasury yields are about 2.4% as of August 10, 2018. The bank sweep deposit interest rate in one of my accounts, with one of the top three retail brokers, was 0.22% (22 basis points) as of July 31, 2018. Although I tend not to leave idle cash in my account, that means the bank could take my deposits, buy one-year U.S. government bonds and pocket the annualized difference between 2.4% and 0.2%.
Earning revenue from your cash is one of the ways brokers make money, even when accounts are otherwise “free.” There isn’t anything inappropriate about this, but you can do a little work and find a better deal. For example, consider the management fee rate on the default-setting money market fund. Is the fee rate competitive? There are ultra-short duration, cash-focused ETFs, like iShares Ultra Short-Term Bond ETF (ICSH), or money market funds that may offer a much lower fee than the broker’s affiliated default option. You can also look at how much the broker’s affiliated bank is paying you for the privilege of using your cash deposits. There are ample one-year, FDIC-insured certificates of deposit (CDs) that pay rates of 2.5% available if you wish to maintain more exposure to cash. There are also high-yield savings accounts that pay annual rates of over 1% and permit more frequent, monthly withdrawals versus a locked-up, fixed-term CD. I keep an allocation to cash in case of emergency, and that money isn’t in my brokerage account. It’s in CDs and a high yield savings account.
Why should you bother?
Small amounts add up to large sums over long periods—the old penny saved is a penny earned. Idling your cash is a missed opportunity, and spending a few moments maximizing the value of that cash can get you moving instead of going nowhere.