Robo-advisor Wealthfront versus Schwab Intelligent Portfolios

There are many robo-advisors (automatic investment platforms) and an equal amount of reviews, but few go in-depth. That’s because it’s hard or almost impossible to compare unless you really try them out, and that would involve investing real money and waiting at least one year to compare. This article reduces the scope to two popular robo-advisors, Wealthfront and Schwab Intelligent Portfolios.

There is no such thing as free lunch

Schwab Intelligent Portfolios claims zero management fees, but if you dive deeper you’ll notice they strongly lean towards their own funds which come with slightly higher fees than funds Wealthfront picks. Schwab spread my portfolio across 25 funds from which 12 are owned by Schwab. After analyzing each ETF, the total expense ratio of my Schwab portfolio comes down to 0.19%. The total expense ratio of my Wealthfront’s portfolio came down to 0.10%.

Wealthfront is the winner in terms of fund’s costs, but given that they charge a 0.25% fee to manage your portfolio versus 0 at Schwab, Schwab comes down as cheapest comparing 0.35% (0.10% + 0.25%) fees at Wealthfront vs 0.19% fees at Schwab. But don’t cheer for too long!

Opportunity cost

The odd things is that Schwab does not allocate 100% of your portfolio to stocks, bonds etc. Instead, it keeps a large portion in cash. For my portfolio the cash part equals 8.69 %. That’s a bunch of cash that just sits there and does not earn any interest. The opportunity cost here is the loss of interest this money would make in a high-yield savings account. Such savings rate varies across banks, so let’s take the current FED’s funds rate at 1.75%. That means you lose out on 1.75% of the 8.69% portion in cash. Let’s say you invested 50k at Schwab, this means you’ll be losing $76 per year in interest. And whenever there is a loser, there is a winner. Read it as follows: Schwab does not give you $76 interest on 50k. Now swap “not giving” with “charging” and we can compare more transparently; Schwab charges $76 on 50k, or 0.15% of your total portfolio.

So, even-though Schwab came out as a winner in terms of lowest overall fees (0%), we have to take this loss into consideration. It’s fairly simple to calculate, the “expense ratio” of your cash is 1.75% (the FED’s funds rate). This brings the total fees of Schwab to 0.33% versus 0.35% at Wealthfront.

Fee waiver at Wealthfront

Above shows Schwab’s fees are marginally lower than Wealthfront’s, but Wealthfront allows you to waive fees by inviting other members, or by getting invited. This program still runs, so by signing up through this link you and I both get 5k managed for free. I feel sorry for those who signed up at Wealthfront without taking advantage of this deal, because it brings Wealthfront’s overall fees closer (or sometimes cheaper, depending on how much you invest) to Schwab’s.

Besides that, for users who signed up prior to April 1st 2018, Wealthfront waves fees for your first 10k. So, on a 50k investment, if you can combine the early-bird waiver + at least one invite, you get 15k managed for free, that’s 30% off their the 0.25% fee on 50k, bringing the total fees down to 0.27%, and yet you have a new winner, Wealthfront!

So, is Wealthfront the winner?

As always in life, it depends. It depends on how much waiver you can get, and it also depends on how much you want to keep in cash. Besides its robo-advisor, Wealthfront has an attractive 1.85% high-yield savings account (update: that recently dropped to 1.27%) which is one of the top rates in US. If you would follow Schwab’s strategy and keep 8.69% of your investments in cash you would be better off at Wealthfront’s, because you would earn 1.85% on that, instead of losing it.

Let’s get back to the drawing board. If you invest 50k in Schwab or 50k minus 8.69% allocated for cash in a high-yield savings account at Wealthfront, who would incur the least costs? We know that 50k at Schwab would cost you 0.33% in fees, which equals to $165. Wealthfront — without waiver —would cost you 0.35%, but you would get 1.85% in interest on the 8.69% portion of cash. Or 1.85% on $4,345 which is $80.

On 50k, at Schwab your fees would be $165, at Wealthfront that would be $79. The clear winner is Wealthfront here.

(($50000–8.69%) x 0.35%) - $80 = $79

Update using FED’s reduced 1.25% yield:

1.25% on 8.69% cash part of 50k is $54.

(($50000 -8.69%) x 0.35%) -$54 = $106

This means that Schwab would be $59/year more expensive, or expressed in percentage, Schwab would be 0.11% more expensive. But continue reading how Schwab offsets this number by tax-loss harvesting.

Wait, what about dividends?

Looking at dividends, Wealthfront’s portfolio generates 3.53% in dividends, while Schwab’s dividend return is 2.34%. These dividends are reinvested in new equities. The winner here is Wealthfront, with 1.19% higher dividend. That’s a second win for Wealthfront, does that mean they’re the clear winner?

Hold one, let’s talk about tax-loss harvesting

Tax-loss harvesting is a technique to generate capital losses. Practically this means an equity is sold at a loss, but immediately after selling a similar equity is bought, so you stay fully in the market. Now, when it’s tax time, you can deduct these losses from your gains, and reduce your overall tax obligation on your capital gains or ordinary income. What’s important to know is that Wealthfront does not offer tax-loss harvesting until you invest $100k. With Schwab it kicks in starting from $50k.

It’s hard to calculate the value of tax-loss harvesting, and it doesn’t happen that often. When the market is down, there is lots of opportunity to sell with a loss, but when the market constantly moves up such losses cannot be generated. And remember that neither Wealthfront nor Schwab invest in individual stocks. So, while there are always is an individual stocks that correct (crash) because of some unexpected one-off event, that often is not being felt in the general ETFs that these stocks are part off. Summarized, tax loss harvesting kicks in when there is a general drop in the market. Oh, and tax-loss harvesting can’t be used for 401ks or IRAs.

So, who is the winner now? Well, it depends on how much money you’ll be investing. If you invest 50k or more, Schwab wins. Note that if we are talking about a personal account (not 401k, IRA, Roth,…) you can’t use tax-loss harvesting.

So, who is the clear winner?

If you arrived here to find out whether you should go for Wealthfront or Schwab, I have to disappoint you. There is no clear winner and the devil is in the details. It depends on how much money you invest, whether it’s a 401k, IRA account or not, whether you can benefit from tax-loss harvesting and whether there is opportunity for this, whether you can lower your fee through referrals, etc. It also depends on the FEDs interest rate, which seems to be on a downhill for now, making Schwab cheaper. Wealthfront may be better for you today, but within a year you may be better off with Schwab. At the end, both services are very comparable in cost, so go for whatever fits you best!