This would’ve been the post that was part two in my “Roboadvisor Guide” series, but then Adam Nash, CEO of Wealthfront, wrote a blog post about the ills of their latest competitor, Charles Schwab’s new robo-advisor product. (I’ll return to my original series next week)
A lot of people liked his post, and I read it too. I liked parts. I laughed, I cried…
It was moving, but there were also some things (a lot of things) in that blog post that I don’t think were fair or intellectually honest, and probably so subtle that I doubt most people even saw it while they were busy experiencing the shock and awe felt in Adam’s missive; so instead of writing about the tools advisers need to offer something compelling in the 21st century, I’m writing this… (and yes, this post is a long one too — I won’t make a habit of this, trust me.)
Now before I begin, I do want to add — I’m not actually sure what Andy Rachleff, the co-founder of Wealthfront and Chairman, had to say about Adam’s blog post because Andy blocked me on Twitter a few days earlier. I had asked him directly why Wealthfront didn’t publish a question I had asked regarding something I thought was contradictory in their blog posts. I gave him a tough time on Twitter about it, because it seemed to me that Wealthfront maybe only wants to post and answer questions publicly that serve their narrative. For what it’s worth, here are the two posts I was bringing to his/their/your attention: Passive Investors Need Less Handholding and The Right and Wrong Reasons to Change Your Risk Tolerance. One post claims their clients are smarter than the average bear and therefore they “don’t need” handholding, but the other says well…maybe they do. But, that’s something maybe I’ll tackle later.
So, Schwab launches a robo advisor. Wealthfront pays attention and launches a messaging counter-attack. Is anyone really surprised yet? No.
What’s at the heart of Adam’s post is this: Schwab has lost its way by saying their robo-service is “free”, when it’s not. But it is free, sort of. The very publicly disclosed truth is, you are paying Schwab for the funds they manage, which are all pretty darn cheap, and are actually some of the same funds Wealthfront uses for their service (that’s right, Wealthfront uses Schwab funds). What isn’t lost on me is that many (but not all) of Schwab’s funds are actually cheaper than the other funds Wealthfront is using within their portfolios… but that’s not helpful to Wealthfront’s narrative is it? To keep this apples-to-apples, Schwab is not charging an “advisory fee” & Wealthfront is — .25% a year. That’s that.
Schwab is marketing the free angle though, and I’m not saying it’s smart marketing to use “free”. I actually think it’s really dumb. Free. So, you don’t value anything about it all?… it’s just free… like that three-legged ikea table sitting on the curb? “You get what you pay for” is what I hear when I think “free”.
So, they went all-in on Free… the truth is, Schwab had it coming; their chin was just hanging out there ready to be clocked. Millennials hate this stuff. So do baby boomers. Gen-X & Gen-Y. Toddlers, too. I even saw a baby nursing… and I showed it Schwab’s announcement about their new “free” service… and you know what happened?… Milk shot right out of that baby’s nose. Right out.
So, not only do millennials and nursing babies hate it… I’m pretty sure everybody hates it when a company tries to get cute. Especially about free. So, -1 for Schwab. Fair enough.
The truth is Adam Nash was smart though, to play it the way he did — he didn’t stop there, he called them out as the bad guy wearing the black hat. And Schwab bit back… Then it became a news cycle. And somehow because he put it on his personal blog, it was so personal — CEO to CEO — just Adam and Chuck Schwab, mano y mano. Then I read Adam’s missive some more, and some things bothered me:
1) Adam makes it personal somehow by putting it on his personal blog, and that’s fine…but it’s not personal. Passion aside, this is business; and your business to to make your business look good. And that’s what this post was about, plain and simple. Mission accomplished? Let’s see….
Highlights from Adam’s post:
Mr. Nash calls out Schwab for their “hidden revenue line” because they use cash in their portfolios, and realize revenue on the cash held in accounts by lending that cash elsewhere, like a bank does.
But that’s not hidden anywhere… you can find that in the public quarterly report. Otherwise, where do you think Mr. Nash found the data?
Then Mr. Nash compared Schwab’s interest rate paid to customers vs. the interest paid to INTERNET banking customers… to maybe imply somehow Schwab is lacking on the interest they pay their customers — maybe they’re even being greedy & nefarious. Aside from that being not fair, that’s almost completely intellectually dishonest, because Mr. Nash must know that Schwab has a nationwide network of physical branches (that cost real money to run)… and do internet banks? No, THEY ARE INTERNET BANKS. People use Charles Schwab and internet banks for different reasons, and they have different expectations and needs. Go to your internet bank at 3:45pm on a Friday and see how quickly you get a check issued to take with you somewhere. But the narrative…
According to Bankrate, the national average is 0.09% (as of this writing), which would’ve been a far more fair comparison; and to their credit, Schwab does seem to be better than average on this front. But that doesn’t fit the narrative, does it?
And Schwab very clearly acknowledges the potential conflict of interest with them using cash as a placeholder in their asset allocation in their client disclosure brochure.
“Because Schwab Bank earns income on the Sweep Allocation for each investment strategy, [Schwab Wealth Investment Advisory] has a conflict of interest in setting the parameters for the Sweep Allocation. In most of the investment strategies, this results in a Sweep Allocation which is higher than the cash allocation would be in a similar strategy in a managed account program sponsored by a Schwab entity or third parties. A higher cash allocation can negatively impact performance for an investment strategy in a rising market.”
So, yes, it is potentially a conflict. A conflict they openly acknowledge. And yes, in a rising market this could negatively impact performance… but that’s not hidden. It’s in their disclosure. And it also assumes in a rising market, but markets (stocks, bonds, real estate)… they don’t always rise, do they? And meanwhile, over on the Bogleheads Forum, people are very publicly asking why their portfolio at Wealthfront only returned 2% in 2014. So, yeah… how you mix a portfolio matters. I get it. But just because Schwab makes money on cash, that doesn’t mean they’re not making the right call by having cash as a position within the portfolio. Let’s continue…
Adam paints Schwab the villain about that cash position a bit more because anywhere from 6-30% of a portfolio at Schwab might be cash. Adam goes on to say… (emphasis mine)
But hey, that’s how you generate $1.7B of net interest revenue. And if you don’t want to take my word for it, Raymond James’ analysts estimate the true customer cost for Schwab Intelligent Portfolios is effectively 0.75%. They even describe it as “a client unfriendly product.”
Okay… So, that’s NOT what the analyst said. What the analyst wrote, and ASSUMED, was this…(emphasis mine)
However, if we were to assume that the average Schwab SIP managed account had 15% of its assets in cash and further assume a blended 70% stock/30% fixed income fund were to return 5% over the long run, having a 15% cash allocation will cost Schwab clients 75 basis points.
So that’s 75 basis points in potential return lost... not “true customer cost”, as Adam calls it. What the analyst is really illustrating is simply how mental masturbation works… let’s cut x% from an imaginary portfolio and put it into cash… and assume a certain fixed return of that portfolio vs. the same portfolio with the extra cash. As convenient as that approach is, that’s just not a very robust way to do real analysis. What would’ve been better, and added real value to this conversation, would have been to actually backtest the proposed mixes at each of the firms, and really see what the difference in performance and fees would be. But Wealthfront didn’t do that, and they didn’t find and highlight an analyst who did either. Why? I have no idea. Maybe it doesn’t fit their narrative. I don’t know. You’d have to ask them.
More on Wealthfront’s assumptions about that cash: Schwab is holding it and Wealthfront then assumes your portfolio is going to suck as a result — at least that’s the narrative I think that is being formed by Wealthfront — in the form of some sort of inevitable opportunity cost. That bothers me most is Wealthfront’s approach to illustrating this, because it’s also using smoke and mirrors.
Example: Wealthfront — here’s the chart they’re proudly flying, in the name of transparency, honesty, and what’s right.
First of all, the part where it says this “should not be construed as a solicitation…” — that’s something they say, even though it obviously is… right? I think it’s called an “advertorial”.
But, again, I digress…
Wealthfront goes on to assume… a lot. They assume that someone with a 40-year timeline at Schwab would possibly be better off with Wealthfront to the tune of over $500,000 (highlighting in bright red) because they’d have a 30% allocation in cash at Schwab. They also illustrate the more likely 6% allocation a 25-year-old would have too — but look at the chart again — where does your attention go based on how they’re presenting their case? The 25-year-old will likely make over $500k less, right? Isn’t that how you read it, too? Maybe not, maybe I’m odd. But if you did read it that way, like me… well that millennial wouldn’t have 30% in cash… they’d probably have 6% — and even though it’s still a loser in this illustration, it’s certainly not nearly as dramatic, is it?
Now back to that Wealthfront graph — Wealthfront also assumes Schwab’s cash only pays 0.12% for the next 40 years. That’s total bullshit — and lame — and sloppy. If you’re going to use forty-year numbers, use historical averages — the Ibbotson historical average is 0.97%, according to Morningstar — but again, that doesn’t fit their narrative — 0.12% (the current historically low rate) plays WAY better for the graph.
Wealthfront assumes, again in the fine print, that both portfolios they’ve created out of thin air — the fully invested Wealthfront portfolio & the portfolios with cash at Schwab — will return the same amount — 6% — as a constant. That’s also probably not true. Maybe Wealthfront’s will return more — maybe less — over the next 40 years. And maybe Schwab’s allocation will be better over the next 40 years, or worse. But that’s unknowable — and it’s also totally disingenuous for Mr. Nash and Wealthfront to try to make their point that way. If they’re all earning 6% over the next forty years, let’s call it a day and roll-up all these robo-advisors into one big RoboGroup already, because they’ll all simply return the same.
Adam uses this exercise to show you how amazing being more fully invested is, using the power of compounding, which is also bullshit — using compounding for this example. I’m not saying it can’t work like that, it just doesn’t — not in the real world. Do all markets go up 6% every year for 40 years? Maybe, but it hasn’t happened yet. Yet it does make for a powerful (not advertising) chart though, doesn’t it? The reality is maybe your number will be higher or lower in real life, but markets simply don’t compound at x% a year.
If you want to assume anything about 40 years into the future when it comes to planning for outcomes (like a financial planner would), do a Monte Carlo Simulation — run both of the firms’ actual portfolios through a model that shows statistical probabilites of outcomes and compare them. And maybe Wealthfront will still come out on top, and maybe not. But to do it the way Wealthfront shows is just not the way a real analysis should happen. Instead, what I see happening is just kind of lazy, or worse.
Now I could take the time to do this Monte Carlo simulation, but this isn’t my fight. And all of this back and forth between Schwab and Nash isn’t really serving anyone but themselves.
To be clear, I’m not saying “Cash” is some great store of value in the long run. It’s not, but as a hedge and ballast to a portfolio, it’s also not terrible, particularly when you consider where bonds are now — and rates too.
Riddle me this… would you rather own a short-term treasury index fund paying you .39% that could drop possibly 5 or 10% in a likely rising interest environment over the next 5 years, OR cash paying .12% (that likely won’t go below parity and will ratchet up as rates go up) over the next 5 years?… Yeah, but the narrative…
And then there’s Adam’s play about Schwab’s approach to indexing, Smart Beta, and how somehow it’s really just about the bottom line for Schwab…
I almost don’t know where to start with Adam’s “Smart Beta” narrative, and how evil Smart Beta supposedly is because this then becomes a religious war among investors. But let me just say this…
Schwab isn’t calling their approach “Smart Beta”… Wealthfront is.
Schwab has some funds, index funds, that equal-weight an index (say the S&P 500) instead of weighing them by their standard market capitalization — and some people call that smart beta. Whether that’s smart or not is totally debatable — and an academically defensible position for Schwab to take. Go ahead…take a look. And while you’re at it, tell me where Schwab’s site highlights or markets “Smart Beta.” So, yes, I agree with Burt… Wealthfront looks idiotic to hammer on Smart Beta.
And while I agree with Adam about how Schwab’s equally-weighted funds do cost more (and I think that’s dumb), Schwab’s Emerging Market Fundamental ETF charges .47% a year. To keep it in perspective, iShares, one of the largest index fund provider’s in the world, has an Emerging Market index fund too. And it costs .69% a year. And maybe that iShares fund is one Wealthfront will use, or has used, and maybe they won’t maybe they’re using iShares other emerging market fund which is cheaper — my point is, we’re not talking about highway robbery here either way.
And on the point of ETFs “paying Schwab”…. Let’s play the same game with Wealthfront. Jump to conclusions… Apex, Wealthfront’s custodian — What are the spreads between the buys & sells; is Wealthfront sure they’re getting best execution? Is there anything nefarious there? I’m not saying there is, but to go around raising these broad questions about the ethics of a firm, like Schwab, which was a firm Wealthfront was trumpeting as the bastion of excellence these last two years until Schwab launched a direct competitor…. yeah. Color me skeptical.
I’m probably already spending too much time on all of this as it is, but the only reasons I’m here is because 1) I’m simply seeking the truth; and 2) I agree with one of my favorite bloggers, Cullen Roche who says, “This is a great time to be an investor… we’re not arguing about how crummy the high fee asset management business is. We’re arguing about how perfect the low fee services are.”
And then, finally, there’s this gem… Adam hammering on fees some more… (again emphasis mine)
“Charles Schwab documents over 14 pages of fees on its website. And as a sweet farewell, if you actually decide to move your account to another brokerage firm, it will take another $50 on the way out. Young investors are tired of this “gotcha”-based pricing.”
Seriously — Let’s simply keep this apples-to-apples.
The service we are supposed to be talking about is Schwab’s robo-advisor, not the fees they charge for foreign exchange services, money wires, overdraft or returned check fees, ATMs, loans, etc. through their brokerage firm (all services Wealthfront DOESN’T offer, by the way).
And that $50 fee — most, if not all, firms also charge a transfer fee when closing an account. I, too, personally think it’s dumb, and agree with Adam on that front, but where he loses me is that somehow the number of pages in their fee disclosure brochure for their brokerage firm is somehow client unfriendly. And that’s just not fair. He’s trying to say Schwab’s robo-competitor isn’t client friendly. And if page numbers do matter and we compare Wealthfront’s SEC filing about their service and Schwab’s about their competitive product — Wealthfront’s is 23 pages, while Schwab’s is 12. But, again, that didn’t fit the narrative, I suppose.
And here’s just what really makes me mad about this whole thing… it’s feeling like another narrative, designed to sell Wealthfront’s side of the story, trumpeting how transparent they are, when they’re just like everybody else. Again, I’d ask their chairman or submit something in their comments section, but that doesn’t work. They answer the questions they want. They’re not better…They’re just willing to do it for .25% a year.
Look, here’s the thing… I really like Adam Nash from what I know about him. He seems like a good guy, and a smart CEO, and he’s passionate about growing his company. (Andy… well that’s another story) Adam’s always been nice to me whenever we’ve spoken or interacted. And again — This isn’t my fight, I don’t know which service might be better for you, but in the end this isn’t what Mr. Nash’s piece ultimately was about. This seemed a lot more like a bitter fight between mom and dad, using the kids as pawns in the game of who will love them more. Everyone loses in that game… but especially the kids.
Now my disclosures: I use Schwab personally and professionally. I like a lot about them, but also don’t think their effort here was what I would’ve launched .. but they didn’t ask me (frankly I think the site is really lacking). I’m doing some analysis for myself on the portfolios they’re offering now to see what’s really under the hood, but reserving my judgement privately or publicly until I do the work. I also don’t think Schwab’s reply to Adam was as on-point as it could’ve been. But let’s also not forget Wealthfront’s iterations to becoming who they are today involved them first being an internet trading game on Facebook, then they were a platform for advisers and investors to use to try to BEAT the market, and now they think buying and holding market-cap weighted indexes funds are the next best thing. So yeah… we’ve all got history.