March 8, 2019

Schwab Intelligent Portfolio Solutions: Investing Made Easier

Can Lessons From Behavioral Finance Drive Value For Robo-Advisors and Clients Alike?

Alec Messino
Kelley School of Business
Indiana University
amessino@iu.edu

Abstract

The emergence of robots, or robo-advisors, in the long-established fields of wealth

management and financial planning is a thriving trend across the financial services industry. In 2015,

Charles Schwab debuted a fully automated investment advisory service, dubbed ​Schwab Intelligent

Portfolios​, which – according to the firm – was considered the only investment advisory service

using sophisticated computer algorithms to build, monitor, and rebalance diversified portfolios based

on an investor’s stated goals, time horizon and risk tolerance – without charging any advisory fees,

commissions or account services fees1. With over $33.3B in assets under management (AUM) as of

mid-20182, Schwab is betting its future that it can add value to clients by mitigating the investing and

behavioral mistakes many investors often fall victim to.

Introduction

Charles Schwab is one of the oldest names in the investment management industry and,

originally founded in 1975, has become one of the largest bank and investment brokers today. For

decades now, Schwab has offered typical wealth management services, including personalized advice

and managed portfolios through its Private Client arm. In the past, these wealth management

1
​Charles Schwab Launches Schwab Intelligent Portfolios™​ (2016) from Business Wire
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Assets managed as of June 30, 2018 (the latest available data from Schwab): Over $33.3 billion in AUM
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offerings have entailed a diversified portfolio of mutual funds/ETFs – with a required minimum

investment of $100,000 to $500,000 – for an asset management fee of approximately 1%. The newly

launched Schwab Intelligent Portfolios allow investors with less capital to receive access to quality

portfolio and wealth services with lower fees, less stress, and professional advice.

The Intelligent Portfolios methodology applies the research of Charles Schwab Investment

Advisory experts to algorithms to build and manage client portfolios of low-cost ETFs with up to 20

asset classes3, as well as an FDIC-insured cash allocation to manage risk, volatility, and opportune

investment ideas4. Investors with as little as $5,000 will receive portfolio allocation advice after

answering a set of 12 questions5 used to quickly gauge their goals and risk tolerance. “We know there

are three controllable variables that have an impact on the long-term success of investors – being and

staying invested; having access to quality investment advice and money management; and keeping

costs low,” said Schwab executive vice president Naureen Hassan6, who leads the team responsible

for Schwab Intelligent Portfolios. “Schwab Intelligent Portfolios addresses each of these key

components of success,” Ms. Hassan went on to say. “It’s easy for investors to get started and stay

invested. It keeps investors’ portfolios on track as markets change without requiring any action on

their part and uses advanced technology to create and manage portfolios based on the same

sophisticated, time-tested approaches to portfolio management used by institutional investors. It

keeps costs down to a new low, while providing access to Schwab investment professionals

24/7/365.” Ms. Hassan made note that less than 30 percent of Americans have consulted a financial

professional about savings or investments within the past five years, according to a report by

FINRA’s Investor Education Foundation7. Investors are more likely to succeed if they are receiving

3
See the white paper "​Selecting ETFs​" on the Schwab Intelligent Portfolios website
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Charles Schwab Investment Advisory, Inc. Disclosure Brochure for Schwab Intelligent Portfolios
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See Schwab Intelligent Portfolios™ Investor Profile Questionnaire White Paper
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Press Release: Charles Schwab launched a fully automated investment advisory service, Schwab Intelligent Portfolios
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Press Release: Charles Schwab launched a fully automated investment advisory service, Schwab Intelligent Portfolios
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professional advice about their finances, and Schwab Intelligent Portfolios is a low cost,

easy-to-understand – yet high-quality – offering designed to do that for the masses.

Behavioral Biases

Schwab, with this product, is helping eliminate some of the frequent biases investors make

when constructing their portfolios and avoid the short-termism thinking eroding potential returns.

Familiarity and Naive Diversification (Globally Diversified Portfolios)

Familiarity (Home) Bias and Naive Diversification are major mistakes in which potential

long-term wealth can be diminished. ​Home bias is the propensity for investors to invest in a high

percentage of domestic equities, despite the benefits of diversifying amongst foreign countries and

their respective equities (Ibbotson and Kaplan, 2000). This bias may simply have arisen due to a

human preference for investing in what investors are already familiar with – rather than investing

blindly in unknown areas of the world. ​While this may be human nature, home-country bias limits an

investor’s available opportunities and can be detrimental to returns given the nature of today’s global

markets: According to MSCI data8, roughly half of all global companies are based outside the United

States, which corresponds to varying global gross domestic product ratios and market cycles. As is

evident (Exhibit 1), it’s often impossible to know specifically which asset class or what country will

perform the best (or worst) in a given year9, so it’s important to be diversified a plethora of asset

classes for optimal risk/returns. Diversifying your portfolio with Schwab’s Intelligent Portfolios10

allows investors to leverage the varying returns of separate asset classes (Exhibit 2) while protecting

on the downside in times of market turmoil. ​In the appendix (Exhibit 3) is a sample Schwab

8
Charles Schwab & Co., Inc. with data from FactSet, MSCI as of September 30, 2016.
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​Source: Schwab Center for Financial Research with data from Morningstar.
10
Read the full white paper​ “​Schwab’s Global Asset Allocation Philosophy​.”
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Intelligent Portfolios asset allocation for a 30-year old in an aggressive portfolio with a goal of saving

for retirement.

Myopic Loss Aversion (Goal Tracker)

Myopic loss aversion happens when investors focus their investment decisions unjustifiably

on the short term, leading them to react too negatively to recent losses and putting long-term returns

in danger (Thaler, 1997)11. This phenomenon is intensified by narrow framing, which is the result of

investors considering specific investments (an individual stock or investment) without taking into

account the bigger picture (the portfolio as a whole or a sequence of investments over time)

(Kahneman & Lovallo, 1993)12.​ ​With Schwab, the portfolios are set to a strategic asset allocation

designed to meet an investor’s risk profile and goals and the algorithm maintains that allocation over

time through daily monitoring and rebalancing. For clients with longer term goals, such as retirement

40 years down the road, Schwab recommends that they periodically revisit their time horizon to

determine the right allocation and level of risk for them as circumstances change. Exhibit 4 shows

that even though there are often short-term fluctuations in the market, investors should remain

invested for the long-term goals they set when constructing their portfolio and refrain from timing to

time the market (Exhibit 5), which is nearly impossible.​ By providing each investor a diversified

portfolio, one is much less likely to engage in “panic selling” and to benefit from staying invested

and capturing all of the positive days the market has to offer.

A tool that Schwab utilizes to mute this myopic loss aversion bias is the ​Goal Tracker​. If your

goal is "off target" due to a dip in the market, don't think first of upping the risk in your portfolio.

Your risk tolerance is your risk tolerance and doesn't change, generally, based just on a change in

your goal's status or changes in the market. Schwab’s Goal Tracker provides investors with a

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​Thaler, R. H., Tversky, A., Kahneman, D., & Schwartz, A. (1997). The effect of myopia and loss aversion on risk taking: An
experimental test. ​The Quarterly Journal of Economics
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​Kahneman, D., & Lovallo, D. (1993). Timid choices and bold forecasts: A cognitive perspective on risk taking. ​Management Science
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hypothetical range of outcomes so when markets dip and your emotions start to get the best of you,

you can come back to the Goals tab and see if you are still "off track" and by how much (Exhibit 6,

7). This provides investors with a more appropriate perspective during the ups and downs of markets

over time. Setting goals and tracking progress toward is an important part of success in investing.

Goal Tracker helps project future outcomes, stress test your plan, and keep you on track towards your

financial goals by providing you with action steps to reach them (Exhibit 8).

Endowment and Disposition Effect (Rebalancing and Tax Harvesting)

Schwab Intelligent Portfolios has leveraged the power of technology to automate the complex

tasks of rebalancing and tax-harvesting and limit the endowment and disposition effects that stop

investors from buying, selling, or rebalancing. In the wake of one of the least volatile years on record

in 201713, the beginning of 2018 saw financial markets surge higher, followed by the first market

correction in two years during February. As part of the Schwab Intelligent Portfolios program,

portfolios are monitored daily for rebalancing purposes, and ​automatically​ rebalanced when asset

class weightings drift too far from their targets14. A disciplined process for rebalancing your portfolio

is important for keeping your level of risk consistent as investments rise and fall (Exhibit 10).

According to Schwab, the number of rebalancing trades will vary depending on the market

environment, but the process is designed to keep your portfolio's risk profile consistent, while not

over trading based on slight deviations from targeted weights for each asset class. Lastly, the

automated tax-harvesting abilities give investors the opportunity to rightfully sell stocks at a loss

instead of holding on (disposition effect) to leverage against potential capital gains in other parts of

the portfolio. This not only improves the tax position of an investors portfolio (Exhibit 9), but

eliminates investments that may be dragging down your portfolios returns going forward. This is one

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​Source: Morningstar Direct and the Schwab Center for Financial Research. Data is from January 1, 2008, to December 31, 2017
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Rebalancing and Tax-Loss Harvesting in Schwab Intelligent Portfolios®

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of the areas where the leveraging of technology is beneficial – simplifying the portfolio management

process makes important features like tax harvesting and rebalancing feasible for all.

Schwab’s Intelligent Portfolios Business Model

Charles Schwab’s Intelligent Portfolios service charges no advisory fee. According to the

firm, it derives revenue from from the following actions15:

● ETFs​: Schwab Intelligent Portfolios invests in Schwab ETFs. This creates revenue for
Charles Schwab through those ETFs expense ratios. Schwab Intelligent Portfolios® also
invests in third-party ETFs, and Schwab also receives compensation for providing shareholder
services to those third-party ETFs.
● Cash​: We believe cash is a key component of an investment portfolio. Based on your risk
profile, a portion of your portfolio is placed in an FDIC-insured deposit at Schwab Bank.
Some cash alternatives outside of the program pay a higher yield.
● Order Flow​: Schwab receives revenue from the market centers where ETF trade orders are
routed for execution.

In aggregate, Schwab is increasing it’s company value by expanding into yet another segment

of the financial services industry and bringing on clients to generate revenue through the funds they

invest in. While Schwab is a large provider of funds and brokerage, they are now tapping into the

growing market of advisory and are positioned, holistically, to serve their clients better and drive

upward shareholder value.

Implementation and Competition

Schwab Intelligent Portfolio stack up well against competition, but some hold a few

advantages over Schwab’s platform. For example, Schwab's $5,000 account minimum is much lower

than Personal Capital ($25,000), Vanguard ($50,000), and Rebalance IPA ($75,000), but can't

compare to Betterment ($0), Hedgeable ($0), WiseBanyan($1), or Wealthfront ($500)16. Another

15
Charles Schwab Investment Advisory, Inc. Disclosure Brochure for Schwab Intelligent Portfolios

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Business Insider: Charles Schwab Intelligent Portfolios Robo Review 2017: Fees, Returns, Investing Services & Competitors

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disadvantage against Schwab Intelligent Portfolio is the lack of a 401K plan and lack of an SEP IRA

account, which almost all of its counterparts currently offer. In implementing its robo-advisor,

Schwab has the potential to cannibalize the revenue of its existing wealth management platform for

do-it-yourself investors. Albeit, the lower-minimum service may provide an opportunity to transfer

early investors to its Private Client division as their account balances grow and their needs become

more complex. The three years following the launch of Schwab Intelligent Portfolios, their standard

diversified portfolio has ranked #1 in fixed income returns and #2 in equities on a three-year trailing

return basis, as seen in Exhibit 11. As more competitors enter the industry and tout their own

platforms, it will take more than just fees and returns that attract new investors. Customer service,

interconnectability of client accounts, and research may be the leading factors of differentiation.

Conclusion

The introduction of automated investing services is a revolution taking the financial services

industry by storm. It is expected that more people will discover and use robo-advisors over time,

because something like Schwab Intelligent Portfolios meets an important societal need in terms of

making investing more accessible, less stressful, and less costly for the everyday investor. That’s a

good thing, because getting more people on track to meet their financial goals is critically important

for humanity and lifting up communities. Merely just getting an investor into a diversified portfolio

of stocks, both domestic and international, and fixed income, instead of the S&P 500 (Exhibit 12),

can improve ones returns and award a high quality of life in retirement. Going forward, it will be

imperative for firms to seek out the biases that cloud investors judgement and to provide steps,

actionable and automated, to demystify the principles investing. If Schwab Intelligent Portfolios and

robo-advisors alike can improve the financial quality of society, small and large – for cheaper than

current alternatives – the disruption in the wealth management space may be cheerfully welcomed.

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Appendix

Exhibit 1

Exhibit 2

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Exhibit 3

Exhibit 4

9
Exhibit 5

Exhibit 6

10
Exhibit 7

Exhibit 8

11
Exhibit 9

Exhibit 10

Exhibit 11

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 Exhibit 12

Additional Citations:

Markowitz, Harry, "Portfolio Selection," ​Journal of Finance,​ March 1952.

Sharpe, William, "Capital Asset Prices: A Theory of Market Equilibrium under Conditions of Risk,"

Journal of Finance,​ September 1964.

Brinson, Gary, Randolph Hood, and Gilbert Beebower, "Determinants of Portfolio Performance,"

Financial Analysts Journal,​ July–August 1986, 39–44.

Ibbotson, Roger and Paul D. Kaplan, "Does Asset Allocation Policy Explain 40%, 90% or 100% of

Performance?" ​Financial Analysts Journal,​ January-February 2000, 26–32.

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