With interest rates rising to levels not seen for years, this is a good time to evaluate where you are parking your cash. Some securities and accounts offer newly attractive annual percentage yields (APY), while other types of securities and accounts offer next to nothing. As interest rates rise, so too do the opportunity costs of leaving your cash in these next-to-nothing accounts – especially some sweep accounts. Here’s what you need to know about the downside of sweep accounts and some attractive alternatives. Consider working with a financial advisor as you work to put your money to work for you.
Understanding Sweep Accounts
A sweep account is a special type of account that can be linked to a bank account or brokerage account. Depending on the brokerage, you may be able to use a sweep account to hold:
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New deposits you aren’t ready to invest yet
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Dividend payouts that you choose not to reinvest
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Proceeds from the sale of securities in your portfolio
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Funds in excess of a target brokerage account balance
Some robo-advisors that offer sweep accounts may even sweep funds into low-risk exchange-traded funds (ETFs). This allows you to keep your money in the market but in the safest way possible and potentially with lower expense ratios compared to traditional mutual funds.
Drawbacks of Sweep Accounts
There are a couple of drawbacks to many sweep accounts. For one thing they typically receive common dividend distributions, which are often low-yielding accounts. If you have a sweep account for convenience be sure to transfer the balance out of those accounts frequently because of their low yield.
Another potential drawback to sweep accounts, whether from a brokerage or a bank, is that there may be a fee attached. Some sweep accounts are free, but many are not. Reviewing the fine print on sweep accounts can help you understand what you’ll pay to maintain it. If the money in your sweep account is invested in money market funds or ETFs, it’s also important to check out the expense ratios for those so you know what they’ll cost to own annually.
Alternatives to Sweep Accounts
Here are five common alternatives to sweep accounts:
Online savings accounts. Online banks, which don’t have the burden of needing to maintain branches, have an edge over traditional banks in terms of the perks and interest rates they can offer. Still, not every online bank may be a good fit for you. For example, as of October 2022, Bask Bank was offering a 3.05% APY. You can find some of the best rates for online savings accounts here.
I Bonds. Known as the Series I Savings Bonds, or iBonds for short, they come in durations that range from one year to 30 years. This bond has two rates: a fixed rate, which is always zero, and an inflation rate, which is linked to the Consumer Price Index for all Urban Consumers (CPI-U). The interest earned every six months is added to the value of the bond’s principal. Also, in May and November, the Treasury adjusts this bond’s inflation rate in line with the latest CPI-U reading. As of October 2022, iBonds paid a 9.62% interest rate.
Certificates of deposit. One way to save and grow your money is to use a certificate of deposit (CD) account. These low-risk banking products essentially lock your money up for a specific period of time in exchange for an interest rate. CDs are offered at many financial institutions, including banks and credit unions, with their APYs typically being some of the strongest. You can compare competitive rates here.
Treasury bills. Treasury bills are short-term securities, which means they come with shorter maturity dates than bonds and notes. Certain types of T-bills have a maturity period of just a few days, but they’re typically issued in terms of four, 13, 26 or 52 weeks. T-bills are assigned a specific face value, such as $1,000, $5,000 or $10,000, but you can usually purchase them for less than that. The amount you pay is called the discount rate. Once the securities mature, the government hands over the full amount of the bill. You can buy them on the government’s TreasuryDirect site.
Money market mutual funds. Money market mutual funds are conservative investments for investors interested in the safety of their principal. These funds invest in high-quality, highly liquid cash equivalents and short-term debt securities with a maturity of one year or less. Unlike the previously mentioned alternatives to sweep accounts, money market mutual funds are not guaranteed, although they are widely seen as low risk and safe.
Bottom Line
As much as some people complain about rising interest rates there can be a silver lining to this trend. It’s the prospect of – finally – getting your cash to work harder for you. As you assess your options keep in mind three key factors: yield, liquidity and a guarantee. The relative importance of these three factors is entirely individual. There’s no one-size-fits-all savings vehicle.
Tips on Investing
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A financial advisor can help you assess options for parking your cash. Finding a financial advisor doesn’t have to be hard. SmartAsset’s free tool matches you with up to three financial advisors who serve your area, and you can interview your advisor matches at no cost to decide which one is right for you. If you’re ready to find an advisor who can help you achieve your financial goals, get started now.
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Use our free asset allocation calculator to get a quick “big picture” view of which types of accounts and securities it would be wise for you to put your money.
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Source: finance.yahoo.com