There’s a debate going on between Charles Schwab, who launched its Charles Schwab Intelligent Advisors service (robo-advisor), and existing robo-advisors, Wealthfront and Betterment about whether Charles Schwab’s robo-advisor service really is free.
Because Charles Schwab wrote that it will recommend a 8-30% cash weighting for its clients depending on market conditions, Wealthfront and Betterment have gone on the offensive to point out that investing such a huge weighting in cash is not only costly in a hypothetical market return scenario, but irresponsible as well.
Charles Schwab can make money off its client’s cash by paying practically no interest, and reinvesting the cash in higher income producing investments. In other words, Charles Schwab can act like a bank, with a much lower funding cost. This may come as a surprise to many, but those who know how the finance industry works know it’s a simple spread business. The more money that can be cheaply procured, the more money can be deployed for hopefully higher profits.
It’s good that Wealthfront and Betterment have pointed out how Charles Schwab can actually make money from its free robo-advisory product. But here’s the thing, when was there ever a free lunch? Furthermore, although Wealthfront and Betterment keep their clients fully invested at all times, Betterment still charges a 0.15% – 0.35% fee and Wealthfront charges 0.25% on money after $10,000. (Betterment is offering a promo now for 6 months fee free) There are also underlying ETF fees, averaging ~0.15%, which the client ultimately pays for their robo-advisors to build their portfolios.
Charles Schwab is charging 0.00% in fees for their robo-advisory service. Yes, if Charles Schwab also charged a 0.15% – 0.35% fee to manage money like Wealthfront and Betterment, while recommending 8%-30% cash, that would be odd. But Charles Schwab isn’t.
Let’s not debate which business model is better. Instead, let’s discuss whether cash can be considered an investment through a logical discussion.
CAN CASH BE CONSIDERED AN INVESTMENT?
I’m of the opinion that cash can absolutely be considered an investment. It’s a bad investment in a bull market if you never end up deploying your cash given the incredibly low return, but ask anyone who lost money hand over fist between 2008-2010 or 2000-2001 whether they would have loved to have cash. I’m sure the answer would be a resounding YES.
The way to better understand Charles Schwab’s 8%-30% cash allocation is to understand how you would use the respective companies for your retirement.
Since Charles Schwab is the relative gorilla with the longest history of operation (1971), it’s reasonable to say more people use Charles Schwab as a total solution to manage all their investments and retirement accounts. Given the roboadvisors have been around for only five years or less, it’s reasonable to say their clients tend to allocate only a portion of their investment allocation with robo-advisors.
Let’s say a client has a total of $100,000 to invest. If a client decides to allocate $10,000 of their $100,000 investable net worth with a robo-advisor, $80,000 in an S&P 500 index fund on his own, and $10,000 in cash for a rainy day, the robo-advisor better invest 100% of the $10,000. If the roboadvisor invested only 70% of the $10,000 in equities, then the overall cash allocation for the investor is now 13%. A 13% cash allocation is not ideal for someone who only wants a 10% allocation.
Given Charles Schwab has a much more comprehensive offering, it’s easy to see an individual allocate a larger portion of their $100,000 investable net worth with Charles Schwab. Let’s say the individual allocates all $100,000 to Charles Schwab who proceeds to invest 65% in stocks, 25% in bonds, and 10% in cash. The end result is a similar 10% cash allocation!
The conflict seems to stem from the fact that Wealthfront and Betterment think they are managing the client’s entire net worth, where in reality, they are probably managing just a slice of the client’s net worth. On the flip side, many more of Charles Schwab’s clients probably do have a larger allocation of their investable net worth with the firm.
I’d love to get some data from Charles Schwab, Wealthfront, and Betterment on what percentage of their client’s investable net worth is being managed by them. Send me an e-mail or leave a comment if you wish.
US DOLLAR INVESTMENT
Besides holding cash as an investment during times of volatility, you can also invest in the US Dollar or any other global currency if you believe it will appreciate (or depreciate). For example, if you were from a European Union country and decided to invest in the USD in March, 2014, you would have seen a 30% return on your investment if you were to convert the USD back into Euros a year later! That’s way better than the S&P 500’s performance during the same duration.
In 1992, George Soros put on a $10 billion short position on the British pound and made $1 billion in a single day after the British government let the pound float. Not bad for a cash investment wouldn’t you say?
MY OWN NET WORTH ALLOCATION EXAMPLE
For the most part, I hate having “excess” cash. But after spending more than a couple hundred thousand dollars on my 2014 house down payment and the subsequent six figure remodeling bill since it was a fixer, I decided that having less than $100,000 in cash at any given point in time was a little too uncomfortable for me. As a result, I’ve made it a mission to get back to at least a $100,000 steady war chest in 2016 and beyond.
Each person must find their own cash liquidity comfort level.
Take a look at my net worth allocation frame work by age post, which has three different frameworks. I currently hold most of my Risk Free portion of my net worth, which cash is considered a part of, in long duration CDs because they yield 100X more than a checking or savings account. By laddering my CDs, I’m assured I’ll always have liquidity every year or two. If I so happen to lose all sources of income between CD liquidity events, that’s where my $100,000 cash pile will kick in that earns a pathetic 0.2% at the moment.
If you read the net worth allocation post, my recommended Risk Free portion for someone age 30 is anywhere between 5% – 25%, depending on which of the three net worth allocation frameworks of mine you’d like to follow. Expenses, surprises, and opportunities come up all the time. Don’t think that just because we’re in a raging bull market where any donkey can make money that we’ll never need a cash cushion again.
Once again, for my Risk Free recommendation, I’m talking about your OVERALL net worth here, not a 5 – 25% cash allocation of your investable assets or investments.
CASH IS KING, CASH IS TRASH
We’re in the final innings of a bull market, so cash is currently trash. It’s very easy to say how everybody shouldn’t have cash when everything else is doing so much better. If the bull market continues, it’s also easy to assail Charles Schwab for its proposed 8-30% cash allocation, which will lead to “cash drag” compared to a 100% fully invested portfolio with whatever pie-in-the-sky return assumptions.
But I can assure you that if there is ever a multi-year correction again, cash will become king once more. The beginning of 2016 is showing how unstable the stock market really is. Everybody will prefer earning 0.1% on their cash rather than losing 30% in the stock market.
I remember the difficult times during the Asian Financial Crisis in 1997, the dotcom implosion between 2000-2002, and the disaster of 2008-2009. People weren’t just taking a hit on their investments. People were getting fired left and right as well. Having to sell something when you don’t have to because of a liquidity crunch is the worst. Don’t ever forget the bad times.
You have a right to complain about an investment service or an actively managed fund that charges a fee for investing too much in cash. Investing in cash is not why you’re paying them for investing a sliver of your net worth.
But if you’re entrusting an institution to handle a large majority of your net worth, then having a certain cash allocation for opportunity or risk management is absolutely a fair position. If that institution is Charles Schwab who is charging zero fees, while your institution charges 0.15 – 0.35% in fees, the uproar does not make sense.
The complaint against Charles Schwab is similar to the occasional complaint I get from a reader who doesn’t like what I write and says he’s never coming back,. I would refund the angry reader his money, but he hasn’t paid for anything in the first place! Readers are free to come and go as they please. In the long-run, the free market will dictate the winners and losers.
Robo-advisors are providing an excellent, low-cost service to the benefit of the retail investor. By lowering management costs, highlighting fiduciary duties, and making it easier for people to invest, more people are less afraid to mobilize their hard-earned savings into something that may grow much faster in value than cash over the course of their lifetimes.
For the portion of assets I’d consider farming out, I personally like the do-it-yourself approach by creating my own low cost diversified portfolio while using free financial tools by Personal Capital to optimize my investments.
But for those who have no interest in actively managing a portion of your assets, then using a digital wealth advisor like Betterment is much better than not investing in anything over the long term. They manage over $20 billion in assets and charge at most 0.25% in fees vs. 2% – 3% by traditional wealth advisors. You don’t even need to fund your account to check out the various types of ETF portfolios they’ll construct for you based off your risk tolerance.
And for those of you who really don’t have any time or knowledge about investing, then allocating a major portion of your net worth to a fiduciary with human advisor for a higher fee is fine as well.
* Charles Schwab charges no fees for its robo-advisory service.
* Charles Schwab can act like a bank and earn a spread on cash deposits.
* Betterment invest 100% of your assets, but charge a 0.15% – 0.25% fee after a certain amount of assets are deposited e.g. Wealthfront is free for the first $15,000.
* Given the different fee structure differences, the battle between Charles Schwab and other robo-advisors isn’t an apples-to-apples comparison.
* Your viewpoint on cash will depend on your investing history, your investing performance, and how much of your net worth is being allocated to another party to manage. If you entered the workforce, started investing, or launched your robo-advisory business in 2010 or later, it’s likely you’ll have a much more rosy view of the stock market, and a much more negative outlook on cash.
* Charles Schwab and Vanguard will become the largest robo-advisors by the end of 2015, despite launching years later due to their enormous overall assets under management.
* Fee-minded consumers win because it’s a race to the bottom for fees while the service offerings continue to get better and better.
* Low fees will mean very little if there’s a downturn e.g. give me a 0.1% return vs. a -30% return.
* Consumers care less about fees with an advisory firm after a certain low level if the products and service are amazing. If consumers did, then a company like Apple with its high pricing wouldn’t exist. Companies must focus on interface, products, and value-added services that relate to the entire financial management experience in order to succeed.
Take Advantage Of Higher Savings Rates
After consistent rate hikes since the end of 2015, you can now get 2.3% from an online money market account with CIT Bank. Back in 2015, you could maybe get 0.2% – 0.3%.
It’s been great to make so much money in the stock market since 2009. Now it’s prudent to start protecting your assets.
Updated for 2020 and beyond.