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Schwab Intelligent Portfolios: The Evolution of the Robo Advisor?

Charles Schwab (SCHW) recently launched its much anticipate entry into the Robo Advisor space, Schwab Intelligent Portfolios. Schwab instantly will become a major player here simply because they are Schwab.

I honest don’t know if Intelligent Portfolios are a good thing for investors or not. I do suspect that the introduction of Schwab Intelligent Portfolios represents a big step in the evolution of Robo Advisors.

Competitor reactions to Schwab Intelligent Portfolios

Betterment CEO Jonathan Stein appeared on CNBC recently and frankly I was taken aback at how critical he was of the new Schwab offering.

Wealthfront’s CEO wrote a very critical post about Schwab’s entrance into the Robo Advisor space.

These reactions alone tell me that Schwab’s Intelligent Portfolios are a big deal and a potential game changer in the Robo Advisor world. Wealthfront and Betterment are two of the stronger players in the Robo Advisor space. Both are well-funded and Betterment has forged a deal with Fidelity to allow them to offer Betterment to the advisors who custody assets with Fidelity Institutional. The reactions of these executives tell me they are more than a bit concerned about Schwab entering their space.

Competitor reactions mean that Schwab’s Intelligent Portfolios are a big deal.

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Schwab Intelligent Portfolios

Schwab Intelligent Portfolios have a low $5,000 minimum investment, they carry no management fees, investors will not incur any direct transaction costs and there are no account fees.

Like most Robo Advisors, Intelligent Portfolios will be powered by algorithms using ETFs across 20 different asset classes, as well as a cash allocation invested in a bank account at a Schwab-affiliated bank.

The Schwab Intelligent Portfolios are bit different than other Robo Advisor models in that they will allocate a significant percentage of an investor’s portfolio to several Schwab ETFs based on the fundamental indexing approach of advisor Rob Arnott. The service will utilize model portfolios for investors based upon their goals and risk tolerance.

Additionally each of the portfolios has a significant allocation to cash via Schwab’s affiliated bank. The allocation would range from 7% for a 30-year-old investor to 15% for a more conservative 65 year-old investor. The cash allocations have initially drawn a skeptical reaction from some financial advisors.

While there will be no fees for the service, Schwab will make money from the expense ratios of the ETFs, as well as the money invested via the Schwab affiliated bank. The Intelligent Portfolios will include tax-loss harvesting for investors with at least $50,000 invested as well as automatic rebalancing.

Additionally Schwab has announced the launch of an institutional version of the Intelligent Portfolios during the second quarter of 2015 for use by financial advisors who custody assets with Schwab Institutional.

The Evolution of Robo Advisors

Schwab’s Intelligent Portfolios represents the latest entry into the Robo Advisor space by a major financial services firms.

Fidelity Investments has formed partnerships with Betterment and Learnvest that allows financial advisors who custody assets with them to offer these services to their clients under their own umbrella. This is a great way for these advisors to court younger clients who might not meet their normal minimums and work with them in a meaningful way until they might become full-service clients in the future.

Vanguard has launched its own Robo Advisor service and it has drawn over $4.5 billion in assets without any advertising. Most of this money has likely come from investors with money already at Vanguard and represents an additional 20 to 40 basis points in revenue on money that is already there.

For the very reasonable fee Vanguard offers clients a financial plan, asset allocation advice, rebalancing and ongoing financial advice. They likely will roll this service out more widely in the near future and they reportedly are thinking of offering a version for financial advisors whom their institutional sales group already calls on.

Overall the Robo Advisor offerings by Schwab, Fidelity, Vanguard, TD Ameritrade and some others represent the next step in the evolution of Robo Advisors.

At some point I envision the use of Robo Advisors by the likes of Schwab and the financial advisors who custody with them almost like Major League Baseball uses the minor leagues as a farm system. Clients who want solid advice but who don’t meet the minimums of many financial advisors will start out in some sort of online service and as their accounts grow and their needs evolve they will move to the “big leagues” and become full service clients.

Overall I view the evolution of the Robo Advisor as a good thing for both clients and financial advisors. For clients this represents another choice in how to get financial advice. For financial advisors it represents a viable way to serve clients who the financial services industry has not done a good job of serving in the past.

Dynamics change as shift from Saving to Spending

The “Robo” approach relies heavily upon a basic “buy/hold/rebalance” investment strategy. This passive strategy can work to your advantage during your accumulation years. These are the years when time is your friend, and dollar cost averaging through market cycles offers the opportunity to give your returns a boost.

However, as we get older and begin to prepare for and transition into our spending years, things change. Unfortunately, too few people realize that the investment strategies that served us well during our savings years turn on their head and work to our disadvantage as the flow of funds reverses and savings turns to spending.

Dollar Cost Ravaging

Suddenly time changes from friend to foe where “dollar cost averaging” turns to “dollar cost ravaging” or what we call, the Mathematics of Catastrophe. (More about which in our next Hub blog). During the second half of your life the simplistic money management approach followed by “Robo- Advisers” can start to look like a “deed of the devil.”

Another concern is that “Robos” are unable to deal with the reality of expense variability. If you believe that in retirement, a fixed, annual withdrawal rate from a diversified portfolio will address your income needs I can with confidence suggest you are at best short-changing yourself and at worst setting yourself up for a cataclysmic financial failure.

I have been in this business a long time and know beyond a shadow of a doubt that a properly constructed life plan is very important in the second half of your life. It is only when you know what you want to do, when you want to do it and what it will cost to do it, that you can start to build the financial framework to make it happen.

Only through your life plan are you able to anticipate years of surplus and years of deficits and take the steps to bend them to your benefit. You need to bring together cash flow optimization, tax management and pension style investment management to make it happen and in the process add hundreds of thousands of dollars to your lifetime assets and cash flow.

Robos ill equipped to link life to investment plan

Linking your life plan to your investment plan is the secret to success, but “robo investing” is not equipped to handle the nuances of that linkage. A Retirement Income Specialist knows that the type of money management you need is much more complex where the cash-flow demands outlined in your life plan need are linked to your investment plan. Tax planning, income optimization and risk mitigation means it is dangerous to leave your investment management running on auto-pilot.

Isaac Asimov’s first law of robotics holds that: A robot may not injure a human being or, through inaction, allow a human being to come to harm.

“Robo-adviser” firms would do well to review this law. When it comes to investors heading into the second half of their lives, “Robo Advisers” may well be about to break it.

Doug Dahmer, CFP, is founder and CEO of Emeritus Retirement Income Specialists. With offices in Toronto and Burlington, Emeritus’ C3 process is one of the industry’s most comprehensive retirement planning processes.

Online financial advisors or Robo Advisors are popping up all over the place and if you believe the financial press they are the future of financial advice. In part I believe they are or will at least shape the future of financial advice. I weighed in on this topic recently via Is An Online Financial Advisor Right For You? for Investopedia.

Please feel free to contact me with your questions.

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Schwab Intelligent Portfolios: The Evolution of the Robo Advisor?