When free is not free
Charles Schwab wants to help you manage your investments for free. I grew up in a world where there was no such thing as a free lunch (before oodles of free information online); I tend to be suspicious of free. [Before I begin, realize that I’m essentially in competition with this free thing. Some bias might leak out of my subconscious.]
What Schwab is marketing is what we in the industry have affectionately labeled a robo-adviser. This is a cloud-based Internet program that will run an investment portfolio for you. The early versions (none of which are providing their companies a profit) charge around 0.25% of the assets managed to do this. As a comparison my firm charges in the range of 0.5 to 1.0% when we have humans manage our clients’ portfolios.
In Schwab’s case, from what I understand, if you have as little as $5000 they will ask you a series of questions and then design, build, and manage a portfolio of low expense exchange-traded funds (ETFs). As I said up top, Schwab isn’t charging 0.5 or 0.25, they are charging 0.0, nada, nothing, zip. Given that building and running a robo-adviser costs money and given that Schwab is not a charity, you may wonder how exactly they can do this.
There are two main ways Schwab will make money. The first, and most obvious place, is in the investments used inside the portfolio. Here the “low cost” ETFs used aren’t exactly the cheapest. They seem to be either proprietary funds from Schwab itself or from companies that kick back a portion of the management fees to them. The latter practice tends to make their fees higher.
A less obvious way that Schwab plans on making this lucrative (for them) is in the allocation of assets in the portfolio. The portfolio would have to maintain a minimum cash position. Why? Most people don’t realize this, but managing cash can often be a big cash cow for an investment company. The cash from the portfolios goes into to Schwab’s bank. With anywhere from 6% to 30% of a portfolio put into cash, there’s a lot of cow.
Of course, what Schwab is doing is not new in the industry. Many of you may want a certain level of cash in your portfolio anyway. While those methods are not the way that my firm chooses to earn money from our clients, we do bill them. In other words, we work for a fee, not for free. Schwab shouldn’t have to work for free or provide its robo-adviser services for free either.
While Schwab isn’t hiding any of this (it’s in the disclosures and descriptions), I’m guessing it looks like a free lunch to most. Now you know there still ain’t such a thing.
This article was published under the title "No such thing as a free lunch" in the Wichita Falls Times Record News on April 5, 2015.
