Look Before You Leap Into Schwab’s New Robo Investment Service

Schwab advertises its new automated investment service as: “No advisory fees, no account service fees, no commissions, period.”


Schwab’s disclosure, which appears on the home page of its website says: “Schwab Intelligent Portfolios charge no advisory fees. Schwab affiliates do earn revenue from the underlying assets in Schwab Intelligent Portfolios accounts. This revenue comes from managing Schwab ETFs™ and providing services relating to certain third-party ETFs that can be selected for the portfolio, and from the cash feature on the accounts. Revenue may also be received from the market centers where ETF trade orders are routed for execution.”

The website has a second disclosure for the cash feature:

The cash allocation will be accomplished through enrollment in the Schwab Sweep Program, a program sponsored by Charles Schwab & Co., Inc. (“Schwab”). By enrolling in Schwab Intelligent Portfolios, clients consent to having the free credit balances in their Schwab Intelligent Portfolios brokerage accounts swept to deposit accounts at Charles Schwab Bank through the Sweep Program.

Is it a free lunch or not? The answer is in the disclosure that contains a lot of vague language that will not mean much to most investors:

– Who are the Schwab affiliates?
– What are underlying assets?
– Revenue comes from “certain” third party ETFs?
– What is a cash feature?
– What is a sweep program?
– What revenues are received for trade execution?
– Schwab’s seems to be executing a two part marketing strategy:

Part one is to leverage its brand name. The strategy just might work. Schwab has spent decades building a brand that represents an alternative to traditional Wall Street products. It was the discount broker when Wall Street was the full service broker.

Part two of its strategy is to create the perception that its services are free (see advertisement). This strategy may also work for investors who do not conduct any due diligence before they invest their assets. They trust Chuck and that is all they need to know.

The key to understanding the conflicting advertisement and disclosure is to know the difference between advisory and management services. Schwab says it does not charge “advisory” fees. That is because the advisory process has been completely automated. You answer questions. Your answers determine which model portfolio you are invested in. Every investor in your model owns the same ETFs with the same allocations. What is the advisory service and who provides it?

Schwab goes on to say it earns revenue from the management of the ETF portfolios and from providing services to third party ETF managers. Suffice it to say ETF management is passive so there are minimal investment decisions. This is why ETF management fees are so much lower than active management fees. Computer programs do most of the work.

So if you read between the lines, Schwab is going to provide free advisory services and make money from management fees when it invests your assets in Schwab and third party products. It also makes money from a “cash feature” when part of your assets are invested in Schwab bank products. When you add it all up Schwab’s free service will produce up to a 0.75% revenue stream from your assets.

The “sweep” program is also controversial. Sweep usually means un-invested assets are swept into an interest bearing account. But, that may not be Schwab’s definition. In this case, there may be a fixed allocation to cash that is based on your tolerance for risk. The amount sits in the bank earning 1% and producing revenue for Schwab, even though there may be alternative investments that produce higher returns.

Schwab is providing a lower cost service, never free, if you compare its offering to traditional financial advisers who charge 1% for advice and 0.25% for ETF management. However, Schwab’s free service is more expensive if you compare it to other automated Robo’s who charge a 0.25% advisory fee and a .025% ETF management fee. I am guessing you are supposed to be willing to pay a 0.25% premium for the brand.

Article originally posted on Paladin Registry.

About the Author: Jack Waymire worked in the financial services industry for 28 years. For 21 years he was the president and chief investment officer of a registered investment advisory firm with more than 50,000 clients. He left the industry in 2003 when his book, Who’s Watching Your Money? was published by John Wiley. That same year he launched an investor information website PaladinRegistry that was based on the principles in his book. Jack is a columnist for Worth magazine, a frequent blogger on major financial sites, and widely quoted in the media including the Wall Street Journal, Forbes, BusinessWeek, Bloomberg, and Kiplinger. Follow Jack on Twitter @PaladinRegistry

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