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Currently Wealthfront Cash account pays 3.8%, way higher than the deposit rates of their 10 partner banks. So I wonder what they do with customer money. I suspect that they use the money to buy term CDs from their partner banks at a negotiated rate higher than 3.8% - so they can still make a profit.

Here is the problem. The account allows customers to withdraw at any time. If many customers withdraw at the same time, say $10 billion in total, then Wealthfront probably would not have enough cash to repay. So they have to sell their CDs at a discount or redeem them from banks at a penalty. Despite that the CDs are FDIC insured, the cash they get from the sales or redemptions may not be enough to repay the customers who ask for their money back. If other customers know this, they would also ask for their money back... Would this be like a bank run?

Note that this problem differs from the problem faced by depositors of a real bank. For a bank, if your deposit account is FDIC-insured, you don't need to worry about loss - if the bank fails, FDIC pays you. But for Wealthfront, customers are not directly holding IOU from banks: they hold IOU issued by Wealthfront, who in turn invests in bank deposits. Even if bank deposits (CDs) are FDIC-insured, before they mature, Wealthfront doesn't get paid. So If many customers withdraw before CDs mature, the FDIC insurance cannot help ensure all customers get paid - unless Wealthfront delivers CDs to customers rather than cash (pay in kind). I think this is a classic risk in maturity transformation.

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  • It can’t be CDs for the reasons you described. Is Wealthfront profitable? That might be the answer…
    – RonJohn
    Jan 15, 2023 at 6:52
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    It is probably a loss leader to attract customers.
    – minou
    Jan 15, 2023 at 11:31
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    This bank run thing is true at every bank. Even your checking account, if everyone withdraws all their checking accounts at the same time they don't get the money.
    – user253751
    Jan 15, 2023 at 14:05
  • @user253751 I edited to explain why this case may be different from general bank runs.
    – RandomBear
    Jan 15, 2023 at 15:47
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    In that case... Ask them how their business model works. If they're legit, they should be willing to give you a general outline so you can decide whether you trust them or not. If they can't or won't, I would avoid them. Secret sauce rarely works.
    – keshlam
    Jan 16, 2023 at 3:47

2 Answers 2

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This is common with "fintech" companies, which Wealthfront even states in their FAQ with small text at the bottom. I personally use a different fintech service that works exactly the same way.

First off:

Cash Account is offered by Wealthfront Brokerage LLC (“Wealthfront Brokerage”), a member of FINRA/SIPC. Neither Wealthfront Brokerage nor any of its affiliates are a bank, and Cash Account is not a checking or savings account.

They are not a bank, but use affiliates like you stated in the question:

The cash balance in the Cash Account is swept to one or more banks (the “program banks”) where it earns a variable rate of interest and is eligible for FDIC insurance.

So to directly answer your question, they simply make a cash deposit in your name at their partner banks. Note that they also have a full legal disclosure which states that the money is covered under SIPC insurance until it reaches the actual banks.

I think that it is less of an "IOU" and more of a "money held in trust for RandomBear" type of situation. So if the bank went under (or there was a run on the partner bank) you would still be the beneficiary because your name is on the account.

If there was a "bank run" on Wealthfront itself, I would assume the same things would happen as a regular bank run. Specifically, withdrawals would be delayed for a few days to give the partner banks time to collect or borrow more cash.

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  • Thanks! This helps. It's good to know that there is no IOU between the brokerage and me. What makes me curious is which types of deposit products they put my money in, in my name. Hard to believe it's demand deposit given the high rate. But if it's time deposits, how can they promise to give my money back whenever I want?
    – RandomBear
    Jan 18, 2023 at 16:04
  • @RandomBear My guess is that the contracts they have with partner banks means they always get back at least the amount they put in (my assumption, no source for that). Why do you think there would be a penalty or the partner bank isn't also paying them at least 3.8%? The partner bank can easily lend out that money at a higher rate (personal loans, etc.) to then make money themselves.
    – Nosjack
    Jan 18, 2023 at 18:18
  • I haven't seen any bank offering demand deposits at such a high rate. For retail depositors, that rate offered by big banks is typically zero. Nowadays 3.8% is more commonly seen among savings accounts and term CDs. For example see Chase: chase.com/content/dam/chase-ux/ratesheets/pdfs/rdny1.pdf
    – RandomBear
    Jan 19, 2023 at 5:48
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    @RandomBear My guess is that the inter-bank rates are higher than consumer accounts. The Fed rate is 4.25 - 4.5 as of today. So the partner bank could be paying Wealthfront 4% and still make money off those deposits off the Fed (or even more off higher-interest consumer loans). Anecdotally, my local credit union has 13 month CDs at 4.25% APY.
    – Nosjack
    Jan 19, 2023 at 17:59
  • It makes sense that 13-month CDs pay 4.25% because they are term deposits and not as liquid as demand deposits. If you want your money back from a CD, you typically need to pay a penalty, or you have to sell the CD in the secondary market. This is different from demand deposits, where you can get your money back whenever you want without any penalty or any question asked.
    – RandomBear
    Jan 19, 2023 at 19:06
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Presumably they do the same things every other bank does: make loans which pay a higher rate than they're paying you (the traditional way banks made money) or other investments (now permitted though many would argue that was a bad change).

Many customers withdrawing money at the same time is always a risk, and the banking system plans for it. For reasonable amounts of unexpected withdrawals, the bank borrows money to maintain liquidity; they can borrow at lower rates than you can (eg from the government at prime rate) so that cuts into their profit but is just part of being in that business.

If there is a run on the bank -- everyone wants all their money out at once, the bank can't borrow that much, and implodes -- then what county you're in, and whether this is a real bank, becomes important.

In the US, that's when FDIC insurance kicks in; banks are required to carry this and it guarantees that each customer will get at least some of their money. I believe that currently each depositor is insured up to $250,000; if you have more than that, to be fully insured you should spread the money across multiple banks. In other countries there may or may not be a similar safety net; do your research.

Note that not everything that behaves like a bank account is a bank account. If the bank offers investment accounts, those are not protected by FDIC insurance; the same is true for investments elsewhere. It's up to you to understand whether your account is or isn't. If in doubt, check the bank's marketing material for your type of account; if still in doubt ask them to send you a printed description of the account which includes that statement.

Of course you can still choose to put your money somewhere that isn't insured. Risk and reward tend to be tied together by market forces, so legitimate (again) investments generally pay higher average returns to justify the risk of losing some or all value; it's up to the investor to decide if they like the odds or not. The market as a whole, and on the average, tends to increase in value... but we've just seen that some changes may only be short-term.

(I expected a correction after the apparently unjustified jump during the first two plague years; unfortunately I guessed right. But it looks like that just puts me back into the overall long-term market rate of return of about 8%. Someone who started investing during the bubble would have been hurt much more.)

There ya go: banking in a nutshell. Your next step is to find out whether your particular account is protected or not, and to what extent.

Caveat: I did say "legitimate". Scams can look pretty convincing until you try to get your money back. I haven't researched Wealthfront. Odds are they're an honest business. But if you haven't checked, you should, preferably before you send them any money.

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