Making Sense of Money Markets and Sweep Accounts; Not All Cash Accounts are Made the Same
Investors are encouraged to think in terms of asset classes: stocks, bonds, alternatives, and cash. It is the last of these that typically gets the least attention and scrutiny. There’s the sense that money markets, the most common type of cash account, are commodities, and that one is much the same as the other. For most of the years since the Great Recession, money market yields have been zero or close to it, reinforcing the lack of scrutiny.
While it’s true there is much less diversity in money markets than, say, alternative investments, we believe it’s a mistake to simply assume one is as good as the next – an assessment less true as yields have improved over the past year. This is especially relevant as the bull market in stocks extends into record territory and bond yields are at historic lows, developments that can drive an increased allocation to cash accounts.
The Difference Between Money Markets and Sweep Accounts
Money markets and sweep accounts both hold short-term investments. Their difference is a relatively simple distinction and one that is familiar to investment professionals, but which may not be apparent to many retail investors and clients. Sweep accounts are the cash accounts that brokerage firms use as the default option for the proceeds from sales and dividends as they arrive. This is a service that is beneficial to the brokerage customer since the account provides for the immediate payment of interest, which is an improvement over a non-interest-paying holding account.
The catch is that due to fee differentials, the rate of return varies widely across brokerage firms and plans. According to Crane Data, in the summer of 2019, the rate of return in brokerage sweep accounts varied from north of 2% to as little as 0.01%. Individual investors may benefit from monitoring these balances manually, occasionally transferring money from a sweep account to a more attractive money market. Using modern rebalancing software, investment advisors can set brokerage sweep accounts to automatically transfer balances to higher-earning money markets, a service that can make a difference over time.
Holdings
Money markets trade in short-term notes – but there are not only different investment policies but different classes of money markets, too. The average maturity of holdings can also differ; money markets can hold securities that mature in 13 months or less. In general, the longer the note, the greater the risk that something could disrupt the issuer or market.
Money markets are classified into three groups: Prime, Government, and Tax-Free. Prime money markets typically focus on short-term commercial paper, Government money markets on bills issued by the federal government and its agencies, and Tax-Free funds on short-term municipal bonds whose interest is exempt from federal taxation.
Risk
As the SEC disclosure requires, “While investor losses in money market funds have been rare, they are possible.” Money markets issued by non-FDIC-member investment companies are not FDIC insured. In the fall of 2008, in the midst of the financial crisis, a prominent money market declared that investors would be facing a loss. It was only the second time in history that a money market fund “broke the buck,” that is, reported a share’s value at less than a dollar. The primary culprit was the holding of debt issued by Lehman Brothers, which was the most prominent victim of the crisis. The previous case occurred in 1994 and involved a much smaller fund. In other cases where valuations have been strained, the sponsoring investment firm has propped up the price using corporate resources to maintain the money market’s one-dollar valuation.
Money markets are considered among the most secure investments. An added level of comfort can be obtained by using an FDIC-member institution (investment limits may apply and rates may not be as responsive to market conditions) or a fund that is 100% government issuance. As in other fixed income securities, higher yields typically come with higher risk, so it may make sense to “look under the hood” at the highest-yielding funds to discover how they are being generated.
Fees and Yield
While the easiest metric to use to compare money markets is yield, an important component to this yield is the fund’s expense ratio. Expenses among the larger money markets can range from 0.09% to 0.42%. One catch is that the lowest expense funds may be institutional class shares that have the highest minimum investment requirements.
Just as in any investment, it makes sense to take the time to match an investor’s goals with the appropriate money market. Spending a little extra effort to analyze money market policies, holdings and fees can be rewarded in terms of risk assessment, investment comfort and optimizing returns.
Blaze Portfolio has advanced options for cash management including real-time accounting, monitoring, and rebalancing. For more information on how these features can help you, contact Blaze for a free personalized tour of the software.