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Schwab Intelligent Portfolios Review Part II: Wall Street’s New Cash Cow

Compare Hedgeable vs. Schwab Intelligent portfolios HERE

Schwab’s new robo-advisor product Intelligent Portfolios has officially launched. This marks a big swing in the industry and it will be interesting to see how it pans out over the next few months.

For some, the conflicts of interest pervading the whole program will be too much of a turnoff — at some point people are going to ask “does Schwab really have my best interest in mind?”

Schwab is generating revenues on the back-end, but the average person probably won’t see or understand how that is happening or how that impacts their portfolio. It makes money from the Schwab ETFs your money is put in, it makes money from the 3rd party ETFs on the platform, and it makes money from the significant chunk of your portfolio (6%-30%) that will be permanently held in cash.

schwab_intelligent_portfolios

This looks a lot like smoke and mirrors

The way your money gets invested directly impacts how Schwab makes money, but yet the program is presented as being completely free to the end user. If Schwab had your best interest in mind, wouldn’t they put you in the best possible product with no biases and just charge you a small fee upfront? The convoluted revenue channels (and the conflicts of interest) just come across as a misdirection, especially considering Schwab’s effort to coat everything with glossy marketing spin.

Why else would Schwab need to go on a 15-page diatribe about how amazing cash is and why you should accept it as a static holding? Probably because it’s compensating for something — namely, the mountain of criticism that is being cast on the platform. Schwab is bringing a whole new meaning to the term cash cow — the more cash you hold, the bigger it gets.

Cash investments play an important role within a well-diversified investment portfolio and serve several purposes, including greater stability, liquidity, diversification and potential inflation protection.

 

Are you sure, Schwab? Does the “important role” of cash also have anything to do with the fact that it is your primary source of revenue? Do you recommend that your high-net-worth Private Clients purchase large chunks of cash too? Is cash a permanent fixture in your Windhaven portfolios? Or, are you just trying to take advantage of your less wealthy clients? As shown below, the interest rate Schwab pays on the cash holdings won’t even be on par with the industry.

Savings Account Rates (Schwab)

Source: NerdWallet

Schwab pays 0.12% on the cash the is held in the program, but earns an average of 1.67%, according to a 1st Quarter 2015 filings with the SEC. Not a bad return, right? Now is it making more sense why they want clients to hold so much cash?

Long-term investors are going to suffer from the cash positions they are forced to take with Intelligent Portfolios, and clients cannot opt out. Excess cash could mean missing out on over 100% of growth over 30 years, which is truly unfortunate for the end user:

Impact of Cash (30yr)

But, hey, at least Schwab will be making money

While most automated investing platforms aim to hold 0% cash (or as little as possible), the algorithm driving Intelligent Portfolios will automatically assume you need a lot of it. Schwab will really pile on the cash for conservative investors, which is a bit more defensible, but there will be high allocations across the board according to a recent white paper.

Schwab Cash Allocations

Source: Charles Schwab

Looking at the middle of the spectrum, it seems that most moderate investors will hold about 12% cash. Using Hedgeable’s Robo Index as a base return and assuming a $100,000 account size, how might that hurt your portfolio growth over 30 years? It could be effectively costing you 127 bps per year:

Cost of Cash

So much for it being “free”

At Hedgeable, we do agree that cash can be beneficial, in some market environments. In fact, all Hedgeable clients can be 100% invested in cash at any time. Cash holdings should not be static though — we only use it when it is necessary, when markets are risky and the greater stability is appropriate. That’s what an intelligent portfolio looks like. Investing in cash in perpetuity is certainly not an intelligent way to invest.

Hedgeable doesn’t make money based on the amount of cash that our clients hold (or any other security, for that matter). That is what an independent asset manager does, and that is how you act in the client’s  best interest — so the client wins. With that said, we look forward to competing with Schwab for those investors who want a sophisticated solution.

If you are a current Schwab Managed Account (Windhaven, Managed Strategies, Private Client) or Schwab Intelligent Portfolio customer, come try Hedgeable 3 Months Free, with code SCHWAB on signup!

Get started with Hedgeable today with as little as $1 to invest!