I read an "investment report" about an online US stock broker, saying that the broker can gain extra earnings from clients' idle money interest without sharing the interest with its clients.
Is that legal and possible?
asked Dec 17, 2022 at 5:22
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4If you the brokerage say “sweep account yields 1.25%” but put the money in a “bank account” which earns 2%, then you get to keep the extra 0.75%. I wouldn’t be shocked or upset at that.– RonJohnCommented Dec 17, 2022 at 9:09
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3That's basically how money market funds work, in a nutshell– littleadvCommented Dec 17, 2022 at 9:15
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It's also how banks work. What protects the depositor is that the banks are required to carry insurance.– keshlamCommented Dec 17, 2022 at 16:54
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1 Answer
Is it legal? Yes. This is called "making a profit". The basic principle behind it is how every business in a free market works: You buy something for $X and then you resell it to a customer for $X+something. The difference is your gross profit, from which you pay your expenses, pay your employees, and if you're lucky have something left over for yourself.
Banks are in the business of loaning money. So they borrow money for some low interest rate and then loan it out at a higher interest rate. The difference is called the "spread".
Stock brokers used to make money by charging their clients a fee for each trade. But with the arrival of discount brokers, those fees have been whittled down to somewhere between peanuts and zero. So how to make money today? One way is to invest the cash balance in a client's account and keep all or most of the profits on that. This is called "float". A client deposits, say, $1000 in his account, and then a couple of days later he uses that $1000 to buy a stock. In those few days the broker can invest or loan the $1000 and make a little money. If the client leaves a little spare cash for a long period, the broker can make more from it. That's typically not a lot per client but if your clients are mostly self-directing trades on the Internet then your costs per client are low. And if you have many many clients, making a few dollars a year from each one adds up.
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1@AGamePlayer (1) Why did you think that? (2) The client can use it whenever they want. (3) Money is fungible. (4) You don’t send them cash; you send them computer bits that represent money. (5) Brokerages and banks are not lawyers which need to put your money in an escrow account. Even then, it’s not cash. (6) Brokerages would need a heck of a lot of safes! And who would organize them?– RonJohnCommented Dec 18, 2022 at 9:20
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1@AGamePlayer Many people have the same thought about banks. They think when they deposit money, the bank puts it in an envelope with their name on it and stores it in the vault (or something equivalent). In reality, the bank loans the money out. That's how a bank makes money. If your broker really kept any cash you gave him in a safe, how would he earn a living? He would have to charge you a fee for his services one way or another. ...– JayCommented Dec 18, 2022 at 21:56
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1@AGamePlayer "they would never use my money to do anything about investment." Right. Investing your spare money is a Big Fat No-No in the US. That (crypto-"currency" exchange FTX sending people's spare money to hedge fund Alameda Research) is part of what got Sam Bankman-Fried into so much trouble.– RonJohnCommented Dec 21, 2022 at 1:42
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1@AGamePlayer but real brokerages don't send your spare money to hedge funds: they send it in bulk to FDIC-insured bank accounts.– RonJohnCommented Dec 21, 2022 at 1:43
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1@AGamePlayer honest brokers, though, will tell you where the money goes. For example, Vanguard’s settlement fund VMFXX has a prospectus which specifies what they buy.– RonJohnCommented Jan 3, 2023 at 11:05