Comparing asset allocation: Schwab vs. Morningstar vs. Fidelity
Asset allocation is perhaps the most important consideration when designing an investment portfolio. Selecting an appropriate mix of stocks, bonds, and cash and maintaining the proportions through regular rebalancing, is about as sure-fire a winning strategy as it gets.
And the online financial service firms are there to help, right? If I just follow the directions on the website, it’ll be easy as pie, right? Wait a minute, hombre, not so fast. Let’s compare the offerings of three large online services: Schwab, Fidelity and Morningstar.
What exactly is “aggressive”?
The first step in selecting an appropriate asset mix is to determine what “investing” style matches your investment time horizon and your tolerance to risk.
If you’re nearing retirement, you want to have a more conservative portfolio than if you’re just starting out. Workforce newbies have the most to gain from a high-risk-high-gain allocation, and more time to recoup, should the markets sour. Likewise, if you’re the type who loses sleep when the markets see-saw, you might be more comfortable with a lower volatility portfolio, and accept that you might have to work an extra year — that may be a good trade-off for you. Each website offers a walk-through questionnaire to help you evaluate where you fit on the spectrum of risk tolerance.
The table below shows the allocation recommended by each company (Schwab(S), Morningstar(M), and Fidelity(F)) for a conservative, moderate, and aggressive portfolio. Each website offers shades of risk in between these three categories, e.g. moderately-aggressive; I’ve chosen these three for simplicity. Each column in the table shows the percentage that would be invested in: US Large Cap Equities, US Small Cap Equities, International Equities, Fixed Income (Bonds), and Cash and Equivalents (e.g. savings accounts and certificates of deposit). Schwab and Morningstar breakout US equities into large and small cap; Fidelity groups them together.
|Large Cap Eq||15||10||20||35||32||60||50||55||80|
|Small Cap Eq||0||3||10||10||20||17|
|Cash & Equiv||30||60||30||5||15||5||5||0||0|
|Avg Annual Return||8.2||5.2||6.1||9.5||6.9||8.7||9.7||7.8||9.7|
Each company has a different idea of what constitutes a “moderate” portfolio. Schwab’s suggestion is relatively heavy in Bonds and International Equities, Morningstar is a bit higher in Cash, and Fidelity is heavy on US Equities.
There’s nothing inherently wrong in having different allocations — investing is more an art than a science. It’s probably more important to stick with an allocation and periodically rebalance, than to finesse a few percent addition or subtraction to any one category.
Rebalancing allows you to take advantage of the times when stocks are valued higher than bonds, to sell some stock and buy some bonds, knowing that someday the markets will swing and the opposite will be true. You can then sell bonds and buy stock. It’s a great way to automate “sell-high-buy-low” and to take some of the emotion out of investment decisions.
The return on investment
The last row of the table is the “average annual return” for each portfolio. I’ve put this data in a graph, below.
Note that Schwab’s “returns” are considerably higher than the other two. For example, Schwab’s return for the Conservative portfolio is more than 2% higher than Fidelity’s, yet they have almost the same allocation. If you enter exactly the Schwab Moderate allocation into Morningstar’s calculator you get 7.3% vs. Schwab’s 9.5%. Two percent may not sound like much, but compounded over 20-30 years, it can make the difference between a squeaking-by retirement and a sail-round-the-world. Hey, I’ll have what she’s having.
If two portfolios have the same asset allocation, and they are reporting different average annual returns, then:
- they are using different indexes to measure the return of categories, e.g one might use the Dow and another the S&P 500.
- they might have studied the return over a different window of time, or
- they might use different indexes and a different timeframe.
Schwab quotes returns over the period 1970-2008, and Fidelity uses 1926-2008. I searched but couldn’t find the timeframe that Morningstar uses. Fidelity listed the indexes it used, but not Schwab or Morningstar.
I also find it quite astonishing that Schwab quotes an 8% return for the conservative portfolio. Remember: that’s 30% cash, 50% bonds, and 20% equities. Eight percent seems like an awfully high number. Perhaps the bonds are “high-yield” (junk)? Hard to believe that you can get 8% out of FDIC-insured investments and US Treasuries. 1970-2008 was a go-go time for equities (remember the tech bubble?). It just seems too good to be true.
What’s the take-away message?
Investing is an art, not a science. I’m a scientist. If investing followed the laws of science, I’d be rich. Ask three investment advisors about portfolio allocation, and you’ll get four answers.
Take the values of expected returns with a large grain of salt. Before you sharpen up that pencil to calculate the future value of your retirement fund 30-years away, keep in mind the error-bars associated with that number. You might want to run a Monte Carlo calculation.
Don’t let analysis paralysis take over. Pick an allocation. Pick a sensible one. Trust the online guidance or not. Talk to a financial advisor or not. But don’t let the flood of numbers get the better of you. The perfect is the enemy of the good.
This post is not intended to either recommend for or against any of the firms mentioned. The information in this post is for educational purposes only.
By day, Helen engineers new materials to make computer chips cheaper, better, and faster. When the son goes down (pun intended), she writes about personal finance at Affine Financial Services.