What to Make of the Great Brokerage Cash War

The brilliance of Fidelity and Vanguard re-igniting a cash war today is quite impressive. This simple marketing move, which highlights the couple of percentage points of yield on cash they are offering, strikes deep at some rival online brokers’ Achilles heel — as it will be very difficult, if not impossible, to respond, due to their massive dependence on harvesting cash to remain in the black.

The Context

How did we get to this point? How did cash become the next competitive battleground in wealth management? From a historical point of view, we’ve actually been in the cash wars for the last 40-plus years with the blending of brokerage and banking beginning in the late 1970s when Merrill Lynch invented the “Cash Management Account.”

The CMA was the first brokerage account that allowed for investing in securities, mutual funds and trading as well as offering bank account-like features to access cash, such as check writing and ATM cards.

For the first time, investors could consolidate their bank and brokerage activities into one account, a brilliant innovation. Billions were accumulated into CMAs, driven primarily from the high rates of returns in their money market funds.  

During the period of high interest rates of the ‘80s and ‘90s, Merrill could sweep idle cash into these money market funds that dwarfed what banks could pay on cash, effectively turning Merrill into a preferred bank alternative.

The discount and online brokers quickly followed suit with their versions of “no account fee” CMAs, and the cash battles were on in full force with the key strategic priority to gather as many assets as these competitors could into their CMA-like accounts.

Economies of scale were in play as technology quickly enabled brokerage firms to enhance their CMAs with credit cards, interchange fees, loyalty points and more, to continue to fuel the asset gathering. 

A funny thing happened, however, along this cash journey, which ended up slowly draining the momentum from the CMA revolution: the 25-plus-year decline in interest rates, which basically hit zero after the financial crisis of 2008-2009. 

For the last 10 years, we have been in a low-rate environment, putting tremendous pressure on money market funds to not “break the buck,” causing serious pain to the discount brokers in the form of hundred-million dollar subsidies to investors in order to keep the net asset value of money funds above $1.  

As a result, all of that idle cash being swept into money funds wasn’t such a great asset gathering strategy anymore; in fact it was becoming a massive liability. Ironically, instead of wanting to be a bank alternative, the discount brokers desperately needed to find a real bank they could offload their cash into.

Through acquisitions, de novo startups and other deal-making, some online brokers have successfully created banks they could leverage to harvest that cash, and their reformed cash sweeps regained that profitability swagger with recent interest rate increases (despite the last Federal Reserve move to lower rates a bit).

Life was good again. So much so, that their strategies have become “live on interest income, while giving everything else away for free” to gather as many assets as possible from their retail and advisory channels.

That brings us full circle to my Econ 101 professor’s wise saying about lunches not being free. The latest salvos from Fidelity and Vanguard in the cash wars of 2019 are once again highlighting the upside-down nature of brokerage pricing.

Timothy D. Welsh, CFP, is President, CEO and founder of Nexus Strategy LLC, a leading consulting firm to the wealth management industry; he can be reached at [email protected] or on Twitter @NexusStrategy. Before becoming an industry consultant and blogger, Welsh worked for Charles Schwab (1999-2005) and Merrill Lynch (1992-1999).