The new “robo-advisor” from Charles Schwab Corp (NYSE:SCHW) rolled out one month ago to mixed reviews. Let’s take a closer look to gauge the value of this automated investment advisory service.
Before we break down the benefits and costs, here are the basic features of the Schwab Intelligent Portfolios:
- Schwab Intelligent Portfolios makes professional advisory services available to anyone with $5,000 to invest.
- To build the portfolios, Schwab uses an “advanced algorithm and the professional insight of the Charles Schwab Investment Advisory, Inc. (CSIA) team.”
- The portfolios consist of exchange-traded funds (ETFs), all selected by the CSIA team.
- Allocations are based upon each investor’s unique risk profile.
- Portfolios include up to 20 asset classes across stocks, fixed income, real estate and commodities, as well as an FDIC-insured cash component.
- Fund performance is monitored by the CSIA team and automatic re-balancing is available to account balances above $5,000.
- Automatic tax-loss harvesting is available for investors with account values of at least $50,000.
- There are no advisory fees, account services fees or commissions charged to the investor.
The Benefits of Schwab’s Robo-Advisor
Value is in the eye of the beholder, and there are no free lunches. These are two universal truths that sound in my mind after looking at Charles Schwab’s robo-advisor.
Beginning with the value, an investor wanting a diversified portfolio of funds with just $5,000 to invest may not find a better deal, especially compared to mutual funds, which are rare to find with minimum initial purchases below $3,000. Therefore, a mutual fund investor with $5,000 would be forced to begin with just one fund, as opposed to starting with 20 ETFs with the Schwab Intelligent Portfolios.
Also, the automatic re-balancing feature helps maintain the investor’s target allocation, which can help reduce market risk associated with the set-it-and-forget-it approach of the buy-and-hold investor. For example, a portfolio with an allocation of 60% stock funds and 40% bond funds that was constructed six years ago would now be heavily tilted toward stocks if the investor had not re-balanced in those years when stocks had returns significantly above historic averages.
The tax-loss harvesting feature (for accounts above $50,000) is also an attractive feature for investors with taxable accounts. Selling securities at a loss to offset a capital gains tax liability can clearly translate into cost benefit for investors enrolled in the tax-loss harvesting service. However, it is not clear how it will compliment the re-balancing feature.
Schwab Intelligent Portfolios Are Not ‘Free’
While there are no fees levied directly upon the investor, the Schwab Intelligent Portfolios are far from free. This is where Charles Schwab has been receiving most of its negative reviews for the new automated investment advisory service.
There are no mutual funds or ETFs on the planet that are free of management fees. With that said, many of Schwab’s ETFs have expense ratios below 0.2%, which competes directly with other low-cost ETF offerings from Vanguard and iShares. Still, most investors are aware that there are underlying expenses for mutual funds and ETFs. Therefore, they may still buy the “free” idea of the robo-advisor service.
However, the real money-maker for Schwab also happens to be the highest and least visible cost to investors. All Schwab Intelligent Portfolios have at least some allocation to cash which is held in an FDIC-insured deposit account at Charles Schwab Bank where it can earn a spread. These profits could easily surpass the ETF management fees.
Also, there is an opportunity cost to investing in cash, which translates into lower portfolio returns over time compared to a portfolio 100% allocated to a balance of stocks and bonds.
In summary, investors looking for a low-cost, diversified portfolio of ETFs with automated re-balancing may find value in Schwab’s Intelligent Portfolios.
However, the greatest beneficiaries of this new robo-advisor tool may be Charles Schwab and its shareholders. Schwab estimates the automated service will attract $400 billion in assets. Shares of SCHW are up more than 23% in the past year, compared to 17% for the S&P 500, and Charles Schwab is sure to take some market share from other firms, such as Betterment and Wealthfront.
Whether or not you are attracted to the idea of automated investment advisory services, it appears as if the robo-advisor industry is here for the foreseeable future and that Charles Schwab will benefit.
As of this writing, Kent Thune did not hold a position in any of the aforementioned securities. Under no circumstances does this information represent a recommendation to buy or sell securities.