You would have to be pretty naïve to believe Schwab built its Robo service for Virtual RIAs. Schwab built the service to compete with rapidly growing Robos (Betterment, Wealthfront, Vanguard) that could disrupt its retail and wholesale asset gathering businesses.
Schwab’s dual distribution systems created a unique marketing challenge. How does Schwab create retail Robo services that do not alienate its wholesale distribution system? The solution was brilliant. It provides “free” advisory services to retail clients.
Why Free Advisory Services?
All of Schwab’s retail competitors charge an advisory fee. That is their primary revenue stream except Vanguard, a double dipper that also owns the investment products. However, Vanguard does provide planning, advisory, and human contact for 30 bps.
Schwab chose not to charge a retail advisory fee so it could market the service to the 7,000 RIAs that custody assets at Schwab. The “free” advisory solution may mislead investors, but it was the key to avoiding the alienation of the RIAs. They could add an advisory fee and there was no competing with a Schwab fee for the same advice. How do you explain two advisory fees to investors?
Downside for RIAs
It stands to reason RIAs will have to compete with Schwab’s retail version. More astute investors, who know they have a choice, will ask:
Why should I pay you an advisory fee when I can get free advice from Charles Schwab?
Investors may be confused by the roles of RIAs and Schwab. A high percentage of investors do not differentiate between advisory (RIA) and money management (Schwab) services. Who makes the investment decisions? What are they paid for their services? What are the key differences between their respective services?
The Schwab bank requirement is an aggressive move to generate a major new revenue stream from investor assets. Forget the marketing spin. It is good for Schwab and bad for RIAs and investors.
- Why would more astute investors pay an asset-based advisory fee to RIAs for frozen assets at Schwab bank?
- How does the RIA add any value for cash management?
- What happens if RIAs want to raise cash to protect principal in down markets?
Advisors with less than $100 million at Schwab will have a 10 bps competitive disadvantage. 70% of Schwab RIAs will pay this penalty, or is it revenue sharing, for not having more assets at Schwab. The penalty may motivate RIAs to move more assets to Schwab.
Free Schwab advisory services and low advisory fees that are charged by other Robos may compress the fees that are charged by RIAs for passive advice and services. Increased transparency for expenses will require more RIAs to provide additional justification for their asset-based fees.
Upside for RIAs
All of the noise about Robos will have little or no impact on RIAs that have minimum asset requirements of $250,000 or higher.
The real threat of the Robos is to commission sales reps who invest smaller asset amounts and to the no-load fund families that market direct to investors.
There will also be limited impact on advisors who provide planning and investment services. For example, when Paladin matches investors to advisors in its Registry 72% say they are seeking professionals who provide planning and investment services. Very few Robos provide both services – Vanguard is a notable exception.
Schwab’s retail Robo service may appeal to younger investors who have not used RIA services in the past, who have little or no need for financial planning, have smaller asset amounts, or are seeking low cost passive management. Older investors who have depended on Traditional Advisors for years will not use Robo services. They need integrated solutions that include planning, advice, and management. Plus, they may obtain insurance and tax advice from their advisors or other professionals who work for the RIAs.
Robo models are based on limited human contact. This keeps their expenses down, which allows them to provide advisory services for 30 bps or less. On the other hand, Traditional Advisors provide personalized services that can be tailored to the specific needs of their clients. And, the personalized advice is based on face-to-face interaction with investors versus answering a few online questions that plug them into model portfolios.
One of the most frequent questions about the Robo model is what will happen in a material down market when investors are driven by fear of material losses. They will want to talk to humans who can explain what is happening and discuss actions that will be taken to protect the value of their assets. This is one of the major strengths of the RIA business model. We will not know the impact on the Robos until we have a material down market, the recent market correction does not qualify as a down market, but we do know fear is one of the primary emotions that impacts investment decisions.