How much does Schwab's cash sweep really cost clients?

A new study into automated investing platforms published Wednesday is attempting to quantify the overall costs of Charles Schwab & Co.’s no-fee robo-adviser on client portfolios. 

The research firm Backend Benchmarking estimated the Intelligent Portfolios platform and its high cash allocation within its cash sweep program could be costing investors more than $500 million in portfolio growth over the past six years. Instead of charging an advisory fee, Schwab’s robo earns revenue through charging for its underlying exchange-traded funds and on interest collected on holding clients’ assets in cash. 

The cash spread, as it’s called, is the difference between what Schwab earns in interest and what it actually pays clients. The practice is certainly nothing new and common with almost all of the big banks using them, and it’s part of the reason clients earn next to nothing in interest in traditional savings accounts. 

Using a high cash allocation to generate revenue has allowed Schwab to market its robo-adviser as technically having no advisory fee, and the brokerage has made its fee structure front and center on its website so customers can read about the practice. Schwab Intelligent Portfolios allows investors to open an account with a $5,000 minimum, and Portfolios Premium, which is subscription based with a minimum of $25,000. 

However, based on a simulated portfolio return using the equity-only and fixed income-only returns of its Schwab Intelligent Portfolio account, which is invested in a moderately aggressive portfolio, Backend Benchmarking is reporting that for the six-year period ending June 30, clients with Schwab Intelligent Portfolios missed out on $531 million in portfolio growth than if Schwab had charged a 0.30% management fee and invested the cash into the same fixed-income assets that are held in the portfolio. 

Backend Benchmarking’s full methodology detailing how it gathered this estimate is outlined in the 30-page report. 

“If we had not introduced this 0.30% management fee, we estimate the no-cash portfolio would have earned investors $1.13 billion more over this period,” the report noted. “Clients would have been significantly better off had Schwab charged a straightforward and transparent management fee instead of deciding to earn revenue through high cash allocations.” 

A Schwab spokesperson declined to comment on the report's estimates.

Other large scale robo platforms, like Vanguard Personal Advisor Services, includes planning for just 0.15% annual management fee with a $3,000 investment minimum. By comparison, independent robo-advisers like Betterment offer investors to get started with any size initial investment for a 0.25% annual advisory fee. 

Moreover, Schwab's revenue model is estimated to have lost $369 million in potential revenue for the firm, according to the report. Backend Benchmarking reached this estimate because Schwab disclosed in the first quarter that Schwab Bank earned around 0.97% on an annual basis on the cash invested, net of what it paid to clients in the program.

By estimating Schwab earns roughly 1%, and portfolios held on average 10% of their portfolios in cash, Backend Benchmarking estimates Schwab earned approximately $185 million in revenue from the cash. Had they charged the 0.30% management fee they would have earned $554 million, according to the report. 

The report follows an announcement in July that the Securities and Exchange Commission is probing the brokerage’s robo platform concerning disclosure issues. Schwab has not detailed the SEC’s investigation, but announced the company will take a potential $200 million charge in the second quarter related to the inquiry.