A wave of retail investor cash may hit the stock market when interest rates reach this level

By Gordon Gottsegen

Brokerages have been paying interest on uninvested cash, but lower rates may convince retail investors to put that money to use

Brokerages are sitting on something that could help fuel a rally in the stock market - piles of uninvested cash.

In a high-interest-rate environment, it pays for investors to keep extra cash on the sidelines. That cash can generate notable interest income when put into a high-yield savings account or CD.

Brokerages knew this. So in order to entice retail investors to keep cash on their platforms when rates were high, many introduced high-yield cash accounts or interest on the uninvested cash in their customers' brokerage accounts.

For example, Robinhood Markets Inc. (HOOD) offered 5% APY on uninvested cash for premium Gold subscribers. Online brokerage Public offered 5.1% through its high-yield cash account. Meanwhile, Webull offered 5% APY on uninvested cash, plus an additional 2% as a temporary promotion for new customers.

Many brokerages competed over who could give customers the highest interest on uninvested cash, and retail investors gladly accepted the "free" money. This led many investors to treat the cash balances on their brokerage accounts as a spare savings account - generating interest and passively growing.

However, this investor behavior isn't typical, according to Anthony Denier, the president and U.S. chief executive of Webull.

"People open up a brokerage account to own stocks, they don't open up a brokerage account to keep their cash," Denier told MarketWatch. "There has been a certain change over the last two years because of all the high-yield products that brokerages and fintechs have brought to market faster than their banks."

Denier said that on average, retail investors typically hold less than 10% of their portfolio's value in cash in their brokerage accounts. Generally speaking, this is the cash that investors transfer in to buy stocks at a later date, or cash from the proceeds of stock sales. So in principle, this money is different from the money retail investors have stored in high-yield savings accounts or CDs - it's specifically set aside to invest.

Read more: Interest rates are dropping. Why so many investors are clinging to cash, CDs and savings accounts.

But because of the interest paid on uninvested cash, investors are holding onto significantly higher cash balances in their brokerage accounts.

"Now we're seeing cash levels at like 25%-30%, which is really, really high," Denier said.

Webull isn't the only brokerage seeing this behavior. A spokesperson for Public also confirmed to MarketWatch that its customers were holding a cash percentage similar to the numbers Webull shared.

Steph Guild, Robinhood's head of investment strategy, told MarketWatch that Robinhood customers held relatively small cash balances before the Fed started hiking rates in 2022. By the end of 2022, Robinhood's premium Gold subscribers were holding $4.8 billion collectively in cash. By the end of August 2024, that figure grew exponentially to $22.2 billion. It's worth noting that Robinhood's number of Gold customers grew from about 1.14 million to around 2 million during that time, so the increasing cash balance outpaces customer growth alone.

"Since rates started rising in 2022, cash became attractive for retail investors," Sam Nofzinger, Public's general manager of brokerage and crypto, told MarketWatch.

What rate will convince retail investors to invest that cash?

This is where the investor dilemma comes in. With the Fed already cutting rates, the interest paid on that uninvested cash is currently on a downward trend. This means it'll be it less attractive to hold cash as time goes on.

Both Robinhood and Public followed the Fed's lead by cutting their interest rates by half a percentage point in the days immediately after the Fed rate cut - pushing their rates to 4.5% and 4.6%, respectively.

Those interest rates are still pretty good compared to the near-zero rates retail investors had access to for about a decade. However, those rates will keep falling with every successive Fed cut, so it may be only a matter of time until uninvested cash gets invested.

According to Guild, Robinhood conducted an internal survey of its users and found that many would still hold onto cash if interest rates dropped to 4.25%. But if rates hit a hypothetical 3.25% interest rate, many would change their tune.

"From a pure rate perspective, we saw the steepest drop-off in intent to stay in cash occur at 3.25% vs. a higher or lower tested hypothetical rate," Guild told MarketWatch via email.

In that same survey, Robinhood asked its customers why they were holding onto cash balances in their accounts. People responded differently, with some saying they were treating Robinhood like a savings account and putting away money for a big purchase or to pay off debt. However, the largest percentage responded that they were accruing interest until they were ready to invest.

That time to invest may be soon.

How will retail investors invest that cash?

Webull's Denier said lower interest rates could help motivate retail investors to flow into equities.

"I think if we see that rate environment come down - where the cash yield is not as attractive as it currently is - and you see money moving out of fixed income institutionally back into equities, people are going to reduce those cash amounts and invest more in equities," he said. "So I'm still very bullish on the market, even though we are at these all-time highs."

But retail investors may put that uninvested cash into other asset classes as well. Public said that it's already seeing customers move out of cash and into other assets like bonds, stocks and crypto on its platform. Public's Nofzinger noted that savvy investors who knew that rates were going to drop moved to lock in higher yields earlier this year using the company's bond products. Those who didn't may be motivated to act soon.

"Folks who haven't been paying attention, will pay attention," Nofzinger told MarketWatch. "As rates start to drop, you'll see folks start to move to the next best option."

What that next best option is may differ person to person. Guild theorized that retail investors won't likely use this uninvested cash to invest in risky assets. Her rationale was that investors kept this chunk of their money on the sidelines throughout 2024's bull market, so it would take a big behavioral switch for investors to gamble with money they were previously playing it safe with. She theorized that this could lead to retail investors diversifying into other forms of investments - kind of like how Public saw a growing appetite for bonds on its platform.

"From a survey we conducted in April 2024, we saw our customer's intent for their cash ranged from 'emergency cash' to 'saving for a home' to 'eventually invest,' so lower rates may not affect everyone the same way," Guild told MarketWatch.

Regardless where that cash goes, it may spark a revival of retail investors participating in capital markets.

-Gordon Gottsegen

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09-25-24 0700ET

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