Depending on your trading strategy, a significant portion of your account balance may be parked in a regular savings account. This money cannot be invested because you will need it to trade in the markets. Although savings accounts offer interest on account balances, the rate of such interest is much lower than what you could potentially earn by investing those funds.
A sweep account helps you bridge this gap between the need for liquidity and the need to earn higher interest on your funds. Curious to find out more about the meaning of a sweep account and how it works? In this article, you’ll find all the answers you are looking for.
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What is a Sweep Account?
A sweep account is a unique bank or trading account designed to enable you to manage your cash balance efficiently. The primary objective of such an account is to ensure that funds lying in your account are not kept idle.
A sweep account does this by automatically transferring (sweeping) the amount over a certain limit available in your bank or trading account into a highly liquid investment option. In most cases, the investment option is a money market fund that delivers returns higher than a typical savings bank account.
How Does a Sweep Account Work?
Now that you’ve seen the meaning of a sweep account, here’s a brief overview of how it works.
When setting up a sweep account with your bank or stockbroker, you’re required to set a particular limit on the amount you wish to retain in your trading account. If you have any funds over and above the set limit, they are automatically swept into a relatively low-risk money market fund of your choice.
Since money market funds are liquid, you can quickly liquidate your investments and gain access to your funds. Additionally, you also get to enjoy higher returns than what’s typically offered by a savings bank account. This way, your funds are not left idle in your account and are instead used more constructively.
The transfer from your bank or trading account to your chosen money market fund always happens at the end of the day. Sweep accounts work the other way as well. For instance, you can also set up the account in such a way that it transfers funds from your investment to your linked bank or trading account once they reach a specific lower limit.
Also Read: How Does a Trading Account Work?
Sweep Accounts: An Example
Here’s a hypothetical example to help you understand just how a sweep account works.
Assume you have a sweep account. At the time of setting up the account, you specified a sweep threshold limit of ₹30,000. A few months later, the balance in your sweep account reaches ₹50,000. Since the balance in your account now exceeds the threshold limit you set for the sweep facility, the amount over your set limit, i.e., ₹20,000 will be automatically transferred to a high-interest earning money market fund you chose when opening the account.
The amount invested in the money market fund continues to earn interest at 6% per annum, which is far higher than the typical savings bank interest rate of say 4%. However, due to an emergency, you use up the funds in your sweep account, causing it to drop to ₹10,000. Now, since the balance in your account is low, your investment is automatically liquidated and the funds are transferred to your sweep account.
What are the Advantages of a Sweep Account?
A sweep account offers plenty of exciting benefits. Here’s a quick overview of some of the crucial advantages you get to enjoy.
- Puts Idle Funds to Use
Sweep accounts transfer excess funds you have no immediate use for into a high-interest-bearing investment option without any manual intervention or initiation.
- Pays Off Debt
You can also automate your sweep account to transfer your excess funds to pay off loans or other debt obligations.
- Helps Manage Finances Better
Since the investment funds that sweep accounts invest in are generally very liquid, you can gain access to your funds immediately much like a regular savings bank account. This makes managing finances a lot more seamless and hassle-free.
What are the Limitations of a Sweep Account?
As with most financial products, sweep accounts also have their own set of limitations. Check out some of the key disadvantages of these accounts.
- Service Fees
The automatic sweep facility is not provided free of charge. The bank or stockbroker with whom you have a sweep account might levy a fee for this service. In addition to this, you might also have to bear entry load or other charges related to the investment that the account makes. This levy of fees can end up reducing the returns that you get from your investment.
- Penalty Charges
Another major disadvantage of a sweep account is the penalty charge that the bank or stockbroker levies on premature withdrawal. Due to the levy of the penalty, you may end up earning less than the interest rate offered by a traditional savings bank account.
Personal Sweeps vs. Business Sweeps
Sweep accounts can be opened by both individuals and businesses. A personal sweep is when idle funds lying in an individual’s account are swept into a high-interest investment account.
A business sweep, on the other hand, is when the funds above a certain threshold lying idle in the business account are swept into a high-interest investment account.
Conclusion
If you know how to use a sweep account, you can make a higher profit. This account will be linked to your investment account and automatic fund transfers will be made when your balance is above and below the limit. The process is simple: your excess money will be invested so it earns more interest.
If you want to minimise the risks without compromising on the quality of support you receive, Bajaj Financial Securities Limited can give you just what you are looking for. With a seamless account opening procedure to get your own demat and trading account, access to various market segments, margin trading facility and more.
