Most people take a simple view of cash: they have a checking account for spending and a savings account for savings, and if they get fancy, they’ll have a CD for longer term savings goals. Power users will change to an online bank with better returns, and that’s about as far as it goes. That certainly works, but we can do a lot better with few downsides and a lot of extra benefits.
I’d like to start with explaining how traditional banks work and then look at alternatives. Basically, banks make most of their money by lending it, either for mortgages, auto loans, credit cards, etc. Federal regulations require they keep a certain percentage of their assets in “cash,” so they pay interest on checking and savings accounts to attract deposits. The larger the bank, the less they need to work for deposits since they have brand recognition. That’s why you’ll see higher interest rates at online only banks (e.g. SoFi, Ally, etc) than at huge brick and mortar banks (Wells Fargo, Chase, etc), they need to pay more to attract customers since they don’t have branches to do so. However, they’ll never pay more than a certain percentage of loan rates, otherwise they’ll lose money. Switching banks is time consuming, so customers rarely do that, which means banks only need to have periodic promos to encourage people to move their money to them.
Let’s compare that to a brokerage. Brokerages offer a variety of features, and most of their money is made on commissions from trades (or for free brokerages, bid/ask spreads) or from fees on funds they run. The friction in changing funds is pretty low, so funds often compete for low fees to attract investors, and the more investors they have, the lower their fees can be (managing $1B isn’t that different from managing $10B in terms of costs). They sometimes offer loans (e.g. margin loans), but that isn’t the core of their business, and those loans are backed by the debtor’s own assets, not the brokerage’s funds, so risk is much lower and not related to deposits by other customers.
So now that the high level differences between banks and brokerages are out of the way, let’s look at products brokerages have and how they line up with traditional banking products:
- Money Market Funds - basically savings/checking accounts, but run by a fund manager instead of a bank; you can select from any number of money market funds, from funds that look to reduce taxes (e.g. buy mostly Treasuries) to funds that seek to maximize returns; interest is generally accrued daily and paid monthly; banks sometimes offer money market accounts, which are similar, but they operate a bit differently, and you only get the one they offer
- brokered CDs - similar to regular bank CDs, but you’re buying them on the open market instead of from your bank; these CDs cannot be broken early like bank CDs, but they can be sold on the market like any stock for the current fair market value; this means they can reduce in value if you sell before maturity, but since you’re able to shop for the best price, you usually get a much better return if you hold to maturity
- t-bills/notes/bonds - similar to brokered CDs, but issued by the federal government in increments of $1000; these are not subject to state and local taxes, and some brokerages allow them to be auto-rolled (when they mature, the same denomination will be purchased); there’s no early redemption, but they can be sold at any time for fair market value
- municipal bonds - buy bonds directly from cities and whatnot; these are usually not subject to state, local, or federal taxes, but also have higher risk due to cities generally being less credible debtors than state or federal governments; I don’t bother with these, but maybe they’re worthwhile in states with higher taxes (mine is <5%, so not that high)
Generally speaking, the brokerage options over a greater return than traditional banking products because it’s trivial for investors to switch products without changing brokerages.
Here’s what I do:
- checking/savings - invested at Fidelity in SPAXX, which currently yields ~5%, and I think it’s ~30% state tax exempt; if my state had higher taxes, I’d probably opt for a Treasury-only fund; switching takes like 30s to enter a trade; Ally Bank savings is 4.25% and money market fund is 4.4%, and I use my brokerage as checking, so I’m getting 5% on all money held there (Ally checking is 0.10%)
- CD - I had a no penalty CD @ 4.75% @ Ally, which was a fantastic rate when I got it; Fidelity offers non-callable CDs @ >5% for periods from 3 months to 5 years, and Ally only offers those rates for 6-18 months (and they’re still lower than Fidelity); I don’t buy any because I buy…
- Treasuries - no equivalent at banks, but they’re close enough to CDs; current rates are 5.2-5.4% depending on term (4 weeks to 52 weeks), and even notes (2-10 year terms) are 4.5-5%; my efund is invested in a t-bill ladder; I bought 13-week (3-month) t-bills every other week and set them to autofill, and my gains live in my money market fund (SPAXX @ 5%); this is half of my efund, with the other half in ibonds; if I need money, I either cancel the autoroll, or I sell the t-bill on the market
Here’s my list of pros:
- significantly higher interest in checking (5% vs ~0.10%); no difference between “checking” and “savings,” they’re all just brokerage accounts
- more options for investment - I now feel comfortable keeping my efund, checking, and regular savings in the same place without having to sacrifice returns
- debit card rocks - Fidelity and Schwab both have worldwide ATM fee reimbursement and low/no foreign transaction fees (Fidelity is 1%, Schwab is 0%)
- can have cash savings and investments in the same place - Fidelity also has my HSA, and I may eventually move my IRA as well
- paycheck comes a day earlier - lots of banks offer this, but often only on their checking accounts
And some cons:
- SIPC instead of FDIC insurance - coverage is about the same, but FDIC is automatic, whereas SIPC requires me to make a claim; I doubt I’ll ever need either
- a lot more options means the UI is a bit more complex; once familiar, it’s not an issue
- some services don’t play nice with brokerages - I keep an Ally account around just in case, and I honestly haven’t noticed any real issues (sometimes I can only link accounts one way, but that’s not an issue)
I switched from Ally to Fidelity last year for my primary bank and I’m loving it, and I highly recommend others give it a shot. If Fidelity isn’t your speed, Schwab works well too. Vanguard doesn’t offer a debit card, otherwise I’d recommend them as well (their money market funds are even better than Fidelity’s). I used to shop around for better savings rates, and now I don’t bother because Fidelity beats all of them on features and average returns (e.g. a better savings rate still loses if checking is near 0%).
Feel free to ask questions.
Yeah, I’m aware, and I did try using my savings account that way for a time. However, I do find value in separate “checking” and “savings” accounts for money organization. Basically, here’s how my money flow goes:
But you’re right, you can get most of the benefit by using a savings as checking (or have checking auto draft from savings). I keep a budget, and this structure keeps me honest (I guess I could have two savings and get the same result).
However, the bank account can’t fulfill other benefits, like state tax savings on interest or the ability to invest part of my savings into t-bills or funds(I can get a CD though). I’ll also need a brokerage account regardless (I’m not getting an HSA through my bank), so this helps consolidate my accounts a bit, and it turns out the debit card is way better than any bank account I’ve had.
What happens if SoFi no longer has the best rates? You either accept that or move elsewhere. You already need direct deposit to get the best rates, when will they add needing debit card transactions as well? That kind of thing is pretty common with banks since they may not need to be as aggressive in getting deposits at some point if the loan market cools. I think that’s a lot less likely to happen at a brokerage, and even if it does, I can just buy other assets, like CDs , Treasuries, etc. So I expect the brokerage to offer a better product more consistently.
I’m not saying anyone should switch immediately, only to consider a brokerage the next time they go shopping for a new account.
I don’t think that’s necessarily true, it all comes down to when you’re likely to need that cash and how much the market has tanked. By the time you have enough assets that the difference doesn’t matter, you also have enough assets where the extra you’d potentially get by investing it doesn’t matter.
Regardless, that’s not really what this is about. I’m discussing bank vs brokerage account, not investing vs not investing cash reserves…
It’s not clear why you don’t have it all sit in brokerage checking instead of split between savings? Personally I find any sort of attempts to “trick” yourself into certain spending behaviors when it would be more optimal to do something else with better discipline to be silly.
How much interest are you making? For every 1000 you have in SPAXX, let’s say you make 5% interest on it, so $50. You can take 30% of that income off of your state taxes, so $15. Let’s say your state taxes are 5% because I’m not sure where you live, so that’s 75 cents per 1000 that you’ve saved (did I do that correctly?). Returns being 5% is highly abnormal, so this is best case scenario at the moment.
Unless you can sell these fully liquid I don’t see the point. You might as well put it into these types of accounts normally if that’s where you want money to be. If your money is truly tied up in t-bill ladders then it seems less liquid than selling stocks.
Good banks have good debit cards.
I’m not married to SoFi, but if it was severe I would move. I already have accounts at most of the big ones so it’s not a big deal to me. Money market accounts are not guaranteed to be the highest rates either, and when I switched a few years ago HYSAs were leading money market returns. When that becomes the case will you move? Personally I don’t keep enough cash to sweat $0-10 per year.
This doesn’t happen at normal banks. This is common with very specific banks that offer really high returns compared to normal HYSAs. I don’t think these sorts of banks are ever worth it unless you’re holding onto a ton of cash, which I also don’t think is good.
It’s relevant because your entire emergency fund strategy changes when you keep most of it in a real brokerage account instead of with money market. You are talking about how to optimize your big pool of cash, but I’m saying that you should focus less on chasing 0.3% returns on your cash and more on keeping less cash around in the first place. I keep about $3-4k cash around liquid as money that I could use today if I needed to. If I need more money for an emergency, I can still cash it out of my brokerage account very quickly without needing to keep the full 6 months worth of expenses tied up in cash. Note that I have a ton of money in raw brokerage because I make too much money to put it all into tax advantaged spaces. If you don’t make enough money to outpace your tax-advantaged spaces it’s possible that you don’t have any money available to play with in raw brokerage to start with.
I’m not sure what you mean by the second part but as for thinking that having your emergency fund in a brokerage account isn’t worth it: if you have very bad luck you might lose money in the short term, e.g. putting money into stocks, market crashes, then you have an emergency. Even in this case, unless you continue to have an emergency frequently and with every downturn, you will still come out ahead of cash if you continue with the strategy after your first emergency. On the flip side, in the average case if you have an emergency without the market being down or best case don’t have an emergency for the first few years, you’ll have outpaced any returns that cash will give you for quite a while, and this will continue to grow indefinitely. Stick it in bonds if you’re risk-averse, but keeping it in cash is wasting money. Cash returns are very high right now and it’s easy to feel comfortable with your 5% money market, but the calculus will change when returns go sub-1% again.
It’s less that and more a reminder to double check spending if I run out early. Our spending isn’t uniform month to month (e.g. may have a car repair, insurance due, etc), and usually my buffer is enough to cover that (e.g. I budget $X/month for car repair, $Y/month for insurance, etc).
So if my checking needs to be manually refreshed, something is probably more expensive than I budgeted for and I may need to update the budget. Or maybe I’ve been slipping on spending and need to make a small adjustment.
Not much. On my checking, it’s like $50-60/year. In savings, it’s about 2-3x that, so something like $200/year. But that’s not counting my efund money, which is invested in t-bills and is like 10x the combined amount in checking and savings.
So I’m saving a few dollars in state taxes on checking and savings, and like $50 or so tax savings from t-bills. So it’s not a ton of money, but it’s free, so I might as well take advantage.
Sure, and a brokerage is the best place imo to have cash parked if you want to chase returns on cash. If money market funds drop, I can look into corporate bonds, municipal bonds, or a variety of other fixed income investments.
If I’m at a bank, I just ride the ups and downs and that’s it.
Yeah, I can sell CDs and t-bills within a couple days, which is way more liquid than I need it to be. Usually I’ll just need money within a couple weeks since I would otherwise transfer money 2x/month.
I’m guessing you were comparing money market accounts, not money market funds. Even so, when returns are extremely low (say, 0.50% for the best savings account), the difference in returns really aren’t interesting.
So I don’t think HYSAs will beat money market funds, based purely on how they are structured, unless you’re talking about promotional rates or something.
Banks borrow at the federal funds rate and encourage deposits at something under that so they can borrow even more. If HYSAs had to pay above the federal funds rate for deposits, that means things are extremely out of whack.
No, I’m talking about how to consolidate accounts and get some better returns and benefits at the same time.
Money market funds essentially are bonds, they’re just really short term bonds with near guaranteed upside. In fact, some money markets buy exclusively Treasury bills or t-bill adjacent securities (like t-bill purchase contracts). That’s why returns for MMFs are so close to t-bill returns, they invest in very similar assets.
So if MMFs tank in returns, so will bonds because that means the Fed funds rate has dropped. However, it’s highly unlikely to go negative, unlike a Treasury fund, because they limit themselves to very short term contracts so they don’t get hit by market risk.
So if preservation of capital is your primary concern and returns are secondary, you really can’t go wrong with money market funds. They’re slightly more risky than savings accounts, but you usually get rewarded handsomely for that slightly increased risk with usually something like 0.50% higher returns vs top HYSAs.
But again, the argument for moving to a brokerage shouldn’t be mainly higher returns, but consolidation, benefits, and options.