I recently wrote a piece comparing my Schwab Robo Intelligent Portfolio to what I call simplicity—a simple three-fund second-grader portfolio with Vanguard’s simple four-fund Target Date 2050 (VFIFX). Since purchasing shortly after the launch nearly three years ago, my Schwab Intelligent Portfolio earned 7.7% annually, while the Second Grader produced a 9.4% return and the target-date fund earned 9.1%.
Schwab thought the comparison was wrong for three reasons, which I share here following conversations with the firm and with David Koenig, vice president and chief investment strategist for Schwab Intelligent Portfolios.
Apples To Oranges
Schwab says: “The asset allocations you’re trying to compare are not really comparable. It looks to us as though you’re in a Schwab allocation with roughly 80% in equities and around 20% fixed income and cash, while the second grader portfolio and Vanguard target fund are 90/10. In a period of very strong equity markets, it’s not surprising that an allocation with a larger equity allocation would have a moderately higher return.”
According to Schwab, I should have used a more aggressive Schwab Intelligent Portfolio to make it more comparable. But we’re going to have to agree to disagree.
As I said in my original piece, all of the bonds in the Intelligent Portfolio were junk or local-currency emerging market debt, and neither behaved like a high-quality bond fund in down markets. None of the bond portfolio in my Schwab Intelligent Portfolio is in investment-grade dollar-denominated bonds—zero!
The now-defunct Schwab Ultra-Short bond fund, once billed as a safe alternative to a money market fund, had a tiny standard deviation right until it lost more than half its value in the last financial meltdown.
Morningstar shows the average junk bond fund lost 26.4% in 2008, much closer to the 37% loss of the S&P 500 total return than the 7.7% gain of the Vanguard Total Bond Market ETF (BND). Local currency bonds also declined, though good data is scarce.
I also agree with criticisms that Schwab has far too much cash, and there are better ways of investing cash than the 0.15% annual percentage yield (APY) in this Schwab portfolio. Earning so much less than inflation is risky.
Finally, even if I had used the Intelligent Portfolio the firm thought more appropriate, it still underperformed the simple second-grader portfolio by 0.80% annually, according to data from Schwab.
Different Risk Levels
Schwab says: “The risk levels of these allocations aren’t the same. Of note, it looks like the second grader portfolio has greater concentration of risk toward U.S. large cap equities due to much less diversification than the Schwab allocation. The risk concentration in the second grader portfolio means that it will tend to outperform globally diversified Schwab portfolios in periods when U.S. large cap stocks do well, but that won’t always be the case. Over time, most investors want reasonable returns and a smooth path to those returns. Portfolio risk matters, especially when it comes to keeping the typical investor invested over the long term.”
Koenig argued the Intelligent Portfolio was more diversified than the second-grader portfolio, as the top 10 U.S. stocks represented about 9.6% of the entire portfolio.
Again, let’s agree to disagree. It’s not the second-grader portfolio that has more exposure to large-cap than the market; rather, it was the Schwab Portfolio that chose to concentrate on parts of the market that have underperformed—mainly small-cap, midcap and value.