What to make of yesterday's Wall Street Journal report on Schwab's 401(k) 'bet'

Brooke’s Note: Think if Apple made noises that it had a strategy for competing with IBM in mainframe computers. It’s a similarly compelling idea that finally – after years of being overshadowed by Fidelity in the 401(k) business – Schwab could use ETFs and heightened advice to win significant market share from the market king. RIABiz has followed the effort closely because we believe RIAs could have a big hand in the 401(k) business in coming years. See: Schwab’s CEO engages in a Q&A about how his company’s deep-discount, more-advice 401(k) plan will work This is a look at The Wall Street Journal’s take yesterday on that issue and the reaction of RIAs to its suggestion that Financial Engines may enter the picture.

Charles Schwab Corp. may be considering outsourcing advice in its 401(k) plans while at the same time betting the future of such plans on a low-cost ETF approach, according to an article in Wednesday’s Wall Street Journal headlined “Schwab’s Bold Bet on ETFs.”

The company has made no secret about its intention to make an index-only platform available it its in 401(k) plans. See: Schwab to make long-awaited move in 401(k) market with an all-indexed mutual fund and ETF strategy.

But the piece in the Journal asserts that the company is putting all it chips on that strategy and can afford to offer this cheap option because they’ve been such a tiny player in the 401(k) space.

Entrenched and motivated

“For a long time, people haven’t been able to figure out the ETF and 401(k) mix,” says Schwab chief executive Walter Bettinger in the Journal. “I think we’re the one company who is entrenched in the industry who has a motivation to do so.”

When asked to better explain what Bettinger meant by that comment, Susan Forman, vice president of Schwab’s corporate public relations, replied via e-mail that Schwab finds itself in a strategically favorable position.

“Because we don’t see the 401(k) business as a ‘feeder’ for our own funds and because we are a relatively smaller player in the industry, we don’t have the entrenched interests that would make a move like this difficult for us,” she says.

ETF-flavored approach

The first phase of Schwab’s new 401(k) platform combines low-cost, index-only investment tools, according to Forman. The ETF-only platform will be the company’s second phase and will come with personalized, independent advice to achieve better outcomes for customers.

“The investment tools, on their own, aren’t the story,” Forman says in her e-mail. “What The Wall Street Journal and others have missed is that it’s the low-cost nature of indexed mutual funds and ETFs that enable us to remove a lot of the expense that is currently impeding Americans from meeting their retirement goals. Our view about the products that make up our new 401(k) platforms is that the key focus is on cost and use of indexed approaches coupled with personalized advice. ETFs are just one flavor.”

More money in retirement coffers

Forman added that index funds also are low-cost tools that offer customized advice and, by Schwab’s estimates, can bring an additional $115,000 in a person’s retirement coffers.

The San Francisco-based firm is not against actively management funds, Forman says, but believes that a combination of index funds and ETFs can bring even better success to individuals.

Bart Bonga: I understand there are
certainly going to be some limitations
to what we as advisors can
do. I don’t think Financial Engines
encroaches on that.

Which engine?

The Journal report quoted anonymous sources stating that Schwab is considering outsourcing its advice to Financial Engines, a well-known company that offers low-cost online advice to participants in 401(k) plans.

However, in the e-mail Forman was quick to note that the company hasn’t finalized who they are going to work with as an independent third-party advice provider. “So, it’s probably premature to discuss this now,” she says.

Forman emphasized that advice is an important part of Schwab’s strategy since only one in four participants receive advice now and three out of every four participants are lagging in their retirement goals.

“It’s worth mentioning that the advice provider, while important, is secondary to the importance and power of the overall offer. Again, it’s the combination of the low-cost investment tools plus the independent advice that will drive the outcomes we’re driving toward with this new platform,” she says.

Turf trouble

The idea of layering on more advice is a great one, says Mike Alfred, founder of BrightScope, a La Jolla, Calif.-based company that provides ratings for 401(k) plans. But he adds that advisors may feel nervous about such a notion.

“Advisors may see that as a conflict,” Alfred says. “They want to provide advice for clients. There are a lot more questions than answers [but] at a high level what they’re trying to accomplish is smart.”

Schwab wouldn’t be the first to outsource advice using Financial Engines. Boston-based Fidelity Investments has a third-party relationship with Financial Engines as an alternative for plan sponsors who choose it.

Fidelity also offers tools, guidance, and education to participants in retirement plans. It, too, uses an open-architecture approach with Fidelity and non-Fidelity funds as well as ETFs. Participants only have access to ETFs in a self-directed brokerage window if the employer makes that option available to participants. See: What the confidential documents uncovered by Reuters say about Fidelity’s future in the 401(k) business

Fidelity also offers discretionary money management to retail and plan participants through Strategic Advisers Inc., an RIA and a Fidelity Investments company.

Craig Watanabe: I don’t see online
tools as competition for an advisor’s
services, rather I see them as
a complimentary offering.

Not threatened

Advisor Bart Bonga, vice president with Rothschild Investment Corp. in Chicago, whose firm manages 60 401(k) plans totaling about $500 million, says he wouldn’t be threatened by another company offering third-party advice.

“I don’t have a problem with that as an advisor,” he says. “To me, working with Financial Engines is almost like selecting a target date fund. I understand there are certainly going to be some limitations to what we as advisors can do. I don’t think Financial Engines encroaches on that.”

Rothschild’s average 401(k) plan contains about $7 million in assets, and the firm has total assets under management and supervision of more than $2 billion.

One of the plans he works with currently uses Financial Engines to dispense advice to participants.

“The plan has a few thousand employees and we can’t do what we’d want to do for all of them,” Bonga says. “They’re all over the country. It’s just too hard to give individual advice.”

Certainly, he says, his firm offers advice to certain participants who have significant assets outside the plan.

Complimentary offering

RIA Craig Watanabe, with Pasadena, Calif.-based Penniall & Associates, Inc., says he too would welcome the decision if Schwab chose a company like Financial Engines. He added that Bettinger has previously discussed the notion of building a network of advisors who would be positioned to offer one-on-one participant advice.

Watanabe points out that last September’s Schwab study, “Advice Matters,” found that 51% of participants would prefer one-on-one consultation with 23% favoring online tools.

“I don’t see online tools as competition for an advisor’s services, rather I see them as a complimentary offering consistent with the results of the Schwab survey.”

Penniall & Associates manages $1.2 billion in assets.