Cash is idle money. It’s not earning anything. One of the financial industry’s solutions to this problem is the cash sweep—to sweep the money into some type of short-term investment and put the cash to work, even if only temporarily.
What is a cash sweep?
A cash sweep is the automatic movement of cash from a non-interest bearing account to one where the money earns interest. Sweeps are done at the close of each business day, and the cash is typically put into money-market funds or bank savings accounts. Money markets are where short-term (less than one year) debt securities are traded. They are considered very safe because their principal value hardly changes and they are very liquid—they are easily bought and sold.
The trade-off for safety is that rates in the money markets and bank savings accounts are very low—from near zero to about 1%, as of the end of 2021. Cash sweeps aren’t meant to make investors a lot of money; they are only temporary until investors decide to use the cash, often to buy stocks, bonds, or other long-term investments with the prospect of higher returns.
Suppose a bond matures and pays out $12,000, which is deposited into an investor’s checking account, where it earns no interest. This investor had previously established a cash-sweep savings account to be triggered when the checking account balance is above $6,000, the amount the investor needs to cover all monthly expenses.
With the $12,000 payment, the checking balance is $16,000. So $10,000 is swept from checking into the savings account, which pays a 0.5% annual rate. The investor expects to make a decision to invest the $10,000 in a large-cap stock fund in a month or two. In the meantime, the $10,000 earns $4.17 in interest per month:
($10,000 x 0.5%)/12 = $4.17
Types of cash sweep accounts
There are several different kinds of accounts that use sweeps, including:
These are automated, computer-driven investment management accounts that have little or no human supervision—a do-it-yourself system for individual investors. Robo-advisors provide cash-sweep services by analyzing an investor’s checking account activity for excess cash that can be swept into an interest-bearing security such as a money-market exchange-traded fund (ETF).
Because robo-advisers are automated and require little or no human input, compared with standard brokerages, they can offer cash-sweep features to investors at a lower cost and sometimes with a better money-market interest rate.
Some robo-advisers offer two-way cash sweeps: They will also move cash back into a checking account from an interest-bearing account if the checking balance falls below a certain level.
Brokerages sweep cash received from dividend payments and capital-gains distributions, and proceeds from securities sales, into a money-market fund, where the cash will be held until it’s invested in longer-term assets. Such funds’ annual returns range from about 0.1% to 1%, and their expenses average about 0.15% to 0.20%.
A cash sweep can automatically move excess funds from a checking account to a savings account or money-market account. Rates can be higher than the returns on money-market ETFs offered by brokerages. As of January 2022, many banks offer rates of about 0.5% on sweeps into a savings account.
Some banks or brokerages charge fees for sweep services. A fee or expense ratio of 0.25%, for example, erodes the return on a money-market instrument earning 0.5%.
Brokerage sweep accounts can be more convenient to investors who may want quicker access to cash to take advantage of an immediate investment opportunity, whereas moving cash from a bank to a brokerage may take a few days to clear. The price of convenience is that many brokerage sweep services offer near-zero interest rates on money-market funds. And if fees are charged by the brokerage, the cost of a sweep account may exceed the interest earned.
Personal accounts and business accounts
Two types of accounts are typically used to accommodate cash sweeps:
- Personal accounts. Sweeps are used to generate interest on excess cash until it is invested in other assets. They are generally not available to individuals to use for debt repayment.
- Business accounts. Businesses often use sweeps for repaying debt and interest expenses, rather than to earn interest on cash balances. These are sometimes referred to as credit sweeps, and they act like prepayment of loan principal. Cash sweeps are useful for businesses because they lower the debt-to-equity ratio, and the business’s creditworthiness is improved for any future borrowing.
Alternatives to sweep accounts
Investors can open their own higher-rate savings accounts from online banks or credit unions, or buy short-term certificates of deposit with their excess cash. The higher rates often are limited. A credit union might, for example, offer 2% but only on the first $2,000; above that amount, the rate might drop to 0.35%.
FAQs about cash sweeps
What are cash sweep provisions?
Provisions refer to cash-sweep requirements toward the repayment of business loans. A lender may want the cash sweep as part of the loan agreement, to make the borrower use part of its excess cash for loan prepayments before using cash for other purposes.
What are the risks of keeping a large amount in a sweep account?
The two main risks of keeping money in a cash sweep are that returns for money-market investments are very small and could be overshadowed by fees and expenses charged by the bank or brokerage. Also, money held in a sweep account is money not invested in stocks, bonds, or other long-term assets that often have higher returns.
On the other hand, holding money in a cash-sweep account sometimes makes sense. The money is readily available for a down payment on a home or a car, for example. A cash balance also can be used to quickly buy securities at lower prices after a slump in financial markets.
Are sweep accounts insured?
Sweeps generally are insured if the money is put into accounts such as money-market deposit accounts or saving accounts. The Federal Deposit Insurance Corp. (FDIC) insures each account to a maximum $250,000. Sweeps into money-market funds or ETFs aren’t FDIC insured, but some may be insured through the Securities Investor Protection Corp. (SIPC), which also has a $250,000 maximum protection for cash.
The bottom line
Cash sweep accounts can be useful as temporary holding places for investors until they decide to buy longer-term assets or use it for purchases. The accounts don’t, however, help an investor’s wealth grow because the returns tend to be very low. Businesses may find cash sweeps more practical for managing their debt, rather than for investment returns.