Schwab’s Stunning Robo-Advisor Announcement

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Schwab’s Stunning Robo-Advisor Announcement

By Alan Gula, Chief Income Analyst

What do data storage and basic investing advice have in common?

As it turns out, they’re both in a “race to zero” . . .

It’s well-known that computer hard drive capacities have increased exponentially, with costs per byte plummeting. And now, with the cloud computing industry continuing to cut prices, storage in the cloud may even become free one day.

This will ultimately be good for customers . . .  but it will create significant challenges for companies in the industry.

Meanwhile, similar pricing pressures in the financial services industry are giving registered investment advisors nightmares.

And to top it all off, a brokerage giant just made an announcement that could alter the investment industry landscape forever . . .

Starting in early 2015, Charles Schwab (SCHW) will offer automated investing advice for free.

The service will be called Schwab Intelligent Portfolios, which the company is branding as “your personal investing algorithm.” Amazingly, the service won’t charge advisory fees, commissions, or account service fees.

Basically, you fill out an online survey, and the algorithm constructs a diversified portfolio of exchange-traded funds (ETFs) that fits your risk tolerance. Rebalancing is automatic, and tax-loss harvesting is available for clients with invested assets of $50,000 or more in their portfolios.

Schwab – a storied, full-service brokerage firm with over $2 trillion in assets – is entering the robo-advisor space in stunning fashion.

Schwab even seems to be taking a swipe at fledgling robo-advisors like Wealthfront with its marketing, which boasts, “The future of investing. From a company with history.”

Wealthfront recently raised another $64 million, bringing its total funding to $130 million… but it’s hard to imagine venture-capital-backed robo-advisors competing with Schwab and Vanguard, another titan that has thrown its hat in the ring.

Schwab and Vanguard are at a distinct advantage, after all, because they manage many of the ETFs that constitute investors’ portfolios. There are two layers of fees associated with a typical robo-advisor – the advisory fees and the ETF management fees – but Schwab Intelligent Portfolios clients will only be charged the ETF management fees.

For example, if the Schwab U.S. Large Cap ETF (SCHB) happens to have an allocation in a client portfolio, then Schwab will earn the 0.04% expense ratio. It’s not a high fee, but over time the service will fund itself from the underlying ETF revenue, and Schwab will build a stronger ETF business in the process.

Free Lunches All Around

As I said back in July, competition and pricing pressures are ultimately good for investors.

The commoditization of basic investment services may be scary for finance professionals, but it means customers will get to keep more of their hard-earned money through lower fee structures.

There’s a saying in finance that diversification is the closest thing that we’ll get to a free lunch. Yet thanks to Schwab, it seems as though this statement isn’t entirely accurate.

Basic portfolio construction, automatic rebalancing, and tax-loss harvesting – in essence, the means to become efficiently diversified – will actually be free.

Bon appétit, investors.

Safe (and high-yield) investing,

Alan Gula, CFA

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By Alan Gula