Several online brokers have announced zero-cost trading. What customers aren’t being told is the brokers are now cashing in on offering very low percentages on uninvested cash.
There are a few golden rules in investment, with “If something looks too good to be true, it probably is” being one of them. The recent decisions by many of the biggest e-brokers to do away with commissions on online stock trades appears to be granting a longtime wish of every investor. This “free lunch” phenomenon has customers assuming they’re getting a golden deal from their brokers.
What people are losing sight of is that every business (especially brokers) is in the game to make money. And the maxim that if something’s free, you’re the product is proving true for investors.
Sweep accounts are a caveat to free equity trading
Brokerage sweep accounts are effectively rest stops for the interest and dividends accrued from an individual or a business’s holdings before they’re directed elsewhere. Rather than money simply sitting there, brokers give investors the option to sweep those funds into one or more secondary locations with the aim of generating further interest.
Most but not all sweeps are FDIC insured which offers some degree of protection for investors—but where their wealth is swept isn’t always in their best interests—in fact, it tends to be very low interest.
Many of these brokers are sweeping resting client cash not into positions which could pay respectable interest or dividends, but rather into their own bank. Meanwhile, their customers only receive interest rates that could range from between about 0.10 and 0.60 percent on the money.
Investors are catching on to things
These low interest rate accounts are all too common, but they are drawing some blowback. A class-action lawsuit has been brought against Merrill Edge alleging deceptive practices and breach of Securities and Exchange Commission standards that led to investors seeing returns as low as 0.05 percent. The lead plaintiff claims that her funds being moved into a sweep account without proper notification and authorization cost her over $20,000.
Merrill Edge has also been accused of deliberately making the small print difficult for investors to have a hope of understanding it, much less granting permission for transfers to a sweep account. And upon closer inspection, it becomes clear that many organizations can offer incentives like zero-cost trading because they’re doing very well off of their customers’ money in other ways
This is arguably an affront to fiduciary duty, and the kind of conduct that underscores the benefit of having a customer-centric investment advisor on your side.
Pay now or pay later
The lure of zero-cost—and even very low-cost—trading loses its luster considering these facts. If your broker is offering either of these options, we strongly advise scrutinizing their terms of agreement to discover exactly what their default sweep option is.
It’s true that while this calls into question some broker practices, these losses are also due to a certain mindset among many investors. Sweep accounts tend to be viewed as something other than a potential investment when they can, if responsibly managed, become another wealth-generating asset. Brokers can rake in the money when investors aren’t paying attention or are undervaluing the potential of sweeps.
This is why these businesses publish their practices for all to see, though the terms are buried in a sea of information. If you find your broker’s fine print a headache, you’re not alone.
The Lindberg & Ripple team specialize in clarifying investment options for our clients so they can make future financial decisions with complete understanding. Our advice is always in your best interests. Reach us at the link below for an informed discussion on wealth management.
Lindberg & Ripple offer customized wealth management, investment and insurance solutions to wealthy families and successful businesses. We help our clients craft a comprehensive wealth planning model to achieve their financial goals with minimum fuss and maximum savings. To learn more, connect with us.