Investors should keep a watchful eye on the yield they are earning on their cash. An investor in a traditional money market fund can now earn more than 4%. By comparison, banks are paying their depositors anything from zero to 0.4%. Investors should always be prudently maximizing the return on their liquid assets.
Understanding where your cash is held is very important. There are five general types of savings accounts. First are traditional savings accounts, which are normally linked to a bank checking account. These accounts don’t earn much, but they offer savers a little relief from a zero-interest checking account. The second type is a high-yield savings account. Normally, these “high yielding” accounts require a substantial deposit for the bank to justify paying you a higher return. Third are cash management accounts, which are referred to as “sweep” accounts, where uninvested cash is “swept” into an interest-bearing account. Cash management accounts are typically associated with a brokerage account. Fourth are money market funds, which are managed by a fund manager and offer daily liquidity. Finally, a “CD,” or certificate of deposit, is an account where an investor agrees to make a deposit for a fixed period-of-time.
Traditional banks have a very different mindset and objective than a money manager. Bankers are not focused on optimizing your cash return because it reduces from their profits. I call this mindset the “banker’s mentality.” Their approach is based on paying depositors the lowest yield that will keep the deposit funding base in place, which is in sharp contrast to the money manager, who is seeking the highest risk-adjusted return after management fees.
The heart of a bank’s profitability is the spread between the bank’s cost of funds and the return on its assets. Bank assets are typically personal and commercial loans plus short-term liquid investments like reserve deposits with the Fed. As of December 15th, the Fed is paying 4.4% on bank reserve deposits, so you can imagine banks have a large appetite for this type of short-term investment. Banks call the profit spread their “net interest margin,” or “net revenue.” Whatever the name, it is the interest received on their assets, less interest paid to their depositors.
Most banks have three different sources of capital besides their equity capital – retail, wholesale, and corporate debt. “Retail deposits” are mostly checking and savings accounts but can be a “sweep” fund or money market fund. “Wholesale deposits” are institutional investors who “shop” for the highest deposit yield. Banks also fund themselves through short-term and long-term “corporate debt” issuance. As you might imagine, interest paid on wholesale deposits and corporate debt issues are highly competitive and market based. By comparison, retail deposit yields greatly lag market-based yields, especially when interest rates are rising.
Many people accept earning very little on their bank deposits in return for convenience and easy access to their funds. However, now is a time for a more critical evaluation of where liquid assets should be held. Nobody wants to leave money on the table, particularly if the beneficiary is a bank!
Gary B. Martin