Cash Not King In Robo Portfolios

March 12, 2015

The Nitty-Gritty Of Cash

Let’s get one thing straight. Both Wealthfront and Schwab include cash in their robo portfolios. What’s really at issue is the cost to investors, and each firm’s business model.


Wealthfront keeps a small cash reserve to cover its advisory fees. The Wealthfront portfolio I looked at this morning had a 0.2 percent cash holding. Schwab’s service holds significantly more—15 percent, in one example.


Cash As An Asset Class

Schwab uses cash as an asset class; Wealthfront uses it for liquidity. By definition, cash is a low-risk, low-returning asset class. In bull markets, cash acts as a drag on portfolio returns.


Cash drag has been quite real over many historical periods, but not all.


Anyone who remembers the dot-com crash and the housing bust can tell you there are times in the market when cash really is king. Schwab’s defense—that cash helps smooth portfolio volatility and perhaps even boosts long-term risk-adjusted returns—could well turn out to be valid.


Still, Nash’s main point—that cash’s expected long-term return is lower than that of a blended portfolio of risky assets—is largely inarguable. All risky asset classes must offer a premium over the risk-free rate to attract investors.


It’s just that the long term is made up of a series of short terms, and some short terms can be brutal. Nash’s argument for full investment will be correct most of the time, but Schwab’s cash allocation will have its moments.


Liquidity Matters

The question is not whether to hold cash, but where. There are real downsides to including cash in a robo advisor.


Let me explain ...


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