What are sweep accounts & why might you use one?

You want to manage your money in the best way you can, but monitoring your accounts frequently and moving money by hand can be a challenge. If you had copious free time, you might be able to regularly spot which of your accounts have "extra" money you could be doing something else with.

Sweep accounts can offer you a way to do this automatically—to transfer the funds over a certain amount to another account. This setup can be used to take idle money and put it somewhere that instead may maximize its potential returns or make it more accessible for you.

Let's look into how a sweep account works, why you might have one and its potential benefits and drawbacks.

A sweep account is a type of bank or brokerage account that provides a convenient way to manage and maximize the use of cash balances. It automatically transfers, or "sweeps," excess funds from one account to another to optimize the returns on cash while helping a specified account maintain a target balance or meet specific requirements.

For example, you might be able to link a sweep account to your checking account and set it up to automatically transfer any money over a certain balance to a higher-yielding account or investment. It also can work the other way and sweep excess money from an investment account and deposit it elsewhere for you to either accumulate or access as needed.

You may be able to take advantage of a sweep account for both personal and business money management. It's a tool that can help you efficiently manage cash balances and optimize returns on money that might otherwise be idle.

You can use a sweep account to help you manage money in many ways, although your options likely will be limited to what your particular financial institution offers. Some of the main ways you might use a sweep account include:

• Managing savings. You could have money over a certain amount in a banking or brokerage account set to sweep into a high-yield savings account, money market account or certificate of deposit (CD). It then conservatively can earn interest or returns until you need it for a short- or midterm goal. This strategy can be particularly useful for building an emergency savings fund or earmarking money for a specific purpose like a vacation or a down payment on a home.

• Setting aside money for short-term use. You could funnel excess money into an account that stores it for you to pay for a short-term need. For example, you could use the funds as the source account for your automatic bill-paying or, conversely, have it be your monthly allowance for nonessential spending.

• Holding funds temporarily. Particularly if your sweep account is culling overage from a brokerage account, you might use this system as an intermediary for uninvested cash you haven't decided what to do with yet. In this case, you'd review what's swept periodically and send it along to another investment or otherwise put it to use.

Sweep accounts for organizations and enterprises serve much of the same functions but with business-centric purposes, such as these:

• Separating cash flow and investments. You can sweep excess money out of the account you use for daily business operations. You could put that money into high-yield investments or money market funds to earn returns until you need it.

• Making vendor payments. You might use sweep accounts to strategically time vendor payments. You could keep funds in a high-yield account and sweep them back into the checking account just before paying vendors, maximizing your interest earnings.

• Automating loan repayment. If your business has loans, you might use sweep accounts to automatically pay down debt. You could direct excess funds toward loan repayment, helping to reduce interest costs.

Sweep accounts aren't always the right solution. The pros and cons may be weighted differently based on your financial goals, risk tolerance and the sweep account's specific terms. Here are the key advantages and drawbacks of sweep accounts:

• Efficient cash management. Sweep accounts automate the process of managing excess cash, allowing you to optimally use funds to maximize returns.

• Higher returns. By sweeping uninvested cash into interest-earning accounts or investment options, sweep accounts provide an opportunity to earn higher returns compared to leaving the cash idle.

• Convenience and liquidity. Sweep accounts provide a convenient and liquid means of providing quick access to cash when needed. Automatic transfers mean minimal manual intervention is required.

• Customization. Depending on the provider, sweep accounts may offer some degree of customization, allowing you to tailor the sweep strategy to your specific needs and financial goals.

• Opportunity cost. While sweep accounts provide higher returns compared to standard checking accounts, they still may offer lower returns than other investment opportunities, such as long-term investments in stocks or bonds.

• Transaction costs. Frequent transfers between accounts can incur transaction fees, especially in brokerage sweep accounts. These charges can reduce the sweep account's returns.

• Interest rate variability. Sweep account interest rates may be subject to change and may not keep pace with inflation. As a result, the real purchasing power of money in the sweep account may decline over time.

Sweep accounts and traditional deposit accounts, such as savings or a money market, both offer ways to earn interest on cash balances. But their purpose, flexibility and options differ.

The primary purpose of sweep accounts is to efficiently manage the balances and optimize the returns of various accounts, including brokerage accounts, by automatically transferring excess funds from one account to another. They act as an intermediary for linked accounts. Deposit accounts are meant to help you store cash safely, usually for long periods of time.

Sweep accounts may offer a certain level of customization. You may be able to set and adjust specific parameters for the sweep process, such as your target balance or the timing and frequency of sweeps. Deposit accounts don't have many features to control. You can make manual or automatic deposits and withdrawals freely. But other than overdraft protection or scheduling transfers, they aren't set up to monitor and move money to and from other accounts.

You can use sweep accounts to invest excess funds into various options, such as money market mutual funds, CDs or other liquid and low-risk investments, depending on the provider and your preferences. Deposit accounts generally only offer competitive interest rates.

While a sweep account can be convenient for managing cash balances, consider your overall financial and investment strategies to decide whether using a sweep account could advance your broader goals. Seeking advice from a qualified financial advisor can give you valuable insights and help you make informed choices.