My readers' comments on Schwab, Vanguard, and Fidelity; Why my banking-expert friend is short Schwab

1) Wow, did I stumble upon more than I realized when I wrote yesterday's e-mail...

In it, I discussed how I learned that Charles Schwab (SCHW) was "screwing me over" by only paying me 0.5% on the cash I held in my brokerage accounts.

A number of my readers sent in e-mails in response, and I'll share some of these comments in today's e-mail.

Richard L. simply wrote to say:

Your posting today is a real gem and worth big bucks to me.

Chris T. added:

I feel as dumb as you must have felt not realizing that the cash in my Schwab trading account was earning almost nothing. I took your suggestion and have moved the 10% free cash in my $5 million trading account into Schwab based mutual funds at 5+%. Extra money never hurts!

Robert E. wrote:

Schwab was doing the same thing to me. I figured it out a while back, but there was still significant money not made. Probably a lot less for me than you, but it still pissed me off. It's safe to say that Schwab isn't my favorite broker. Fidelity's money market rates went up with Treasuries.

Lee D. pointed out that it's worse at many banks:

At least they were paying 0.5%; the banks are rolling along at 0.01% for the most part and Citibank (C) recently changed theirs to 0.00% – yup, no interest and some years ago they took away sweep arrangement into money market funds. (Oh, but we do get free checking without a $30/month fee!)

Treatment like this is why I am looking at new banking alternatives.

Thanks for your words of wisdom.

Stephen M. has a similar story:

After reading your post about Schwab, I wanted to add that Merrill Edge is also paying very little interest on their brokerage cash and settlement accounts (around 0.5%). Like you, I also could not find the interest rate listed on their website. I had to look into the "recent activity" page and scroll through the interest received and manually add up the previous year of interest payments.

I'm helping my retired sister-in-law manage her ex-401k account that is primarily in cash (her wishes). Since Merrill pays next to nothing in interest, we purchased new issue brokered [certificates of deposit] through Merrill in her account at an average interest rate of 4.75%. (All issued by Wells Fargo, since I read your post that your banking expert buddy thinks it's the safest big bank). She's now receiving over $5,000 per year in interest!

I really enjoy your posts and advice!

One reader took me to task, saying I shouldn't blame Schwab – that I was at fault for not paying attention.

This is true... But I think good companies should try to do right by their customers rather than exploiting their ignorance/inattention for their own short-term gain.

A few other readers pointed me to this page on Schwab's website, www.schwab.com/cash-investments.

But the answer didn't come up when I typed "What interest am I earning on my cash?" in either the search bar or chatbot... and the link to this page is buried amid many other links in the main pulldown menu at www.schwab.com – here's what that menu looks like:

(The page is the eighth item in the "Investment Products" column: "Cash Solutions & Rates.")

And I didn't know where to find it in the menu bar once I logged into my account:

Lastly, even if I had found this page, it merely discloses the interest rates paid by various products – but still doesn't tell me what the default option was (i.e., what I was earning).

So is any bank or brokerage doing the right thing?

Well, some other readers weighed in on this regarding the other two major brokerages – Vanguard and Fidelity.

Bruce Z. writes:

Vanguard automatically puts your cash in VMFXX which pays 5.2%+ right now. That's your cash/settlement account. So at least on this, Vanguard is better to the client than Schwab.

Seems Fidelity does the same thing – I just looked at my wife's Fidelity account – the cash account is in SPAXX (same type of MMF as VMFXX) and it's paying 4.95%.

Wilbur U. agrees:

Over the last 20 years I have managed accounts for friends and myself at Schwab, Fidelity, and Vanguard.

Schwab's policy with their settlement account has been the worst of the three. I have personally witnessed Schwab's raw deal with settlement accounts.

During the pandemic, Schwab's settlement account fund offered about 0% interest. But since interest rates across the board were near 0%, it was acceptable.

But now Schwab's settlement account offers about 0.5%, while Vanguard and Fidelity offer close to 5% on their settlement accounts.

That's why I have recently moved my taxable accounts at Schwab to Fidelity.

Ashoka J. adds another twist:

Schwab also screwed me until about two months ago. I realize that they are very backward in handling client cash. If you move funds into one of these 5% money market funds and have an investment idea, it takes a day to withdraw the funds and put them back in your trading account, which means you have lost the opportunity to invest at the price you want and when you think you want buy.

So Schwab is screwing you twice.

Consider moving the money to Fidelity where every penny is automatically invested in an account paying 5% currently. And, importantly, when you need that money you just go ahead and buy the stock or whatever. There's no need to sell and move money from the account paying 5%. It is all automatic and smooth. They're very smart operators at Fidelity.

Joe G. elaborates:

For retail investors, the big three are Schwab, Fidelity, and Vanguard. Schwab is the only one of the three that does not offer an option to sweep idle cash into a money market fund.

I've been a Schwab customer for many years. They made this change in sweep a few years ago and now it's one of the main ways they make money.

Vanguard has the lowest fees on various funds and good auto sweep features, but by all accounts has by far the worst customer service of these three. If you think you will never use customer service, it is probably the best of the three, but I do find myself wanting to talk to someone on occasion.

Fidelity has the best cash management features by far. I did a bit of research over last few months and decided that some time later this year I'm going to open a Fidelity account for that reason.

Joe also gave his comparison of Fidelity versus Schwab:

Fidelity advantages:

• Fidelity's biggest advantage for its brokerage offering is the money market account (MMA) sweep, which includes check writing sweeps (a cashed check first comes out of the MMA sweep, then out of MMA premium). Schwab's only sweep is a low-interest bank account, so it ends up requiring a ton of manual sweeping to one of the MMAs. In other words, Fidelity is very convenient/easy to use in conjunction with high-yield MMAs and check writing/deposits, while Schwab is not.
• NOTE: Fidelity has two kinds of accounts: brokerage and CMA (cash management account). I want a brokerage that allows a core sweep into an MMA. CMA is only good for a zero-fee debit card, and for those who want to separate their spending from their brokerage account and NOT allow a sweep in case the CMA gets hacked (which is possible given that you are likely to share your linked Fidelity checking account numbers sometimes when making payments). For how I intend to use it – brokerage makes sense.
• T-bill auto-roll functions perfectly (Schwab can leave you uninvested for up to a week).
• ETF fractional purchases (Schwab allows fractional purchases on stocks and mutual funds, but not ETFs). This matters especially if you're using [iShares 0-3 Month Treasury Bond Fund (SGOV)], something I may do a lot starting May 28 (see discussion below).
• Automatic ETF purchases.
• Fidelity premium MMA pays a slightly better rate than Schwab's MMA (very minor).
• Free wires (domestic cash wires).

Schwab advantages:

• Customer service is supposedly much better than Fidelity (or Vanguard or anyone else).
• Easier to navigate website (Fidelity's is such a mess that often the only way to find what you need on the site is using the internal search function or with Google).
• Better inventory and bid/ask spreads for fixed income.
• Fidelity weirdly freezes people's accounts. Sometimes this has to do with sending checks to Fidelity. Sometimes... who knows. Very few issues with Schwab in this regard.
• Some people report Fidelity can be slow/painful to deal with in resolving estates. No such reports about Schwab.
• Futures trading is available and done well. I've never done futures trading so at the moment this does not matter to me.

And finally, he circled back to SGOV:

By the way, I see little discussion of SGOV.

SGOV is relatively new, but it's just an ETF for 1-3 month Treasuries that has a number of attractive properties, including (state) tax efficiency and expense being held to 0.07%. Its main disadvantage today is that it's only two-day settlement (versus one for MMAs), but starting May 28 all ETFs go to one-day settlement. At that point, SGOV will offer several minor advantages to most money market fund offerings and as far as I can tell no disadvantages.

Boris S. agrees with Joe about SGOV:

For bonds, I found SGOV as my vehicle of choice. 13-week Treasuries, purchased weekly. Current weighted yield is 5.4%, super low management fee, very liquid, and almost 100% exemption from state income tax.

2) My banking-expert friend, whom I quoted extensively in many e-mails in early February (archive here), thinks that what Schwab is doing is likely to catch up with it... which is one of the reasons his fund is short SCHW.

He sent me a detailed e-mail with his thoughts, which he kindly gave me permission to share with my readers here. As he says:

I saw your write-up on SCHW today and thought I'd pass along a few comments as I think the stock is incredibly overvalued – and one of the primary reasons is exactly the dynamic that you pointed out. Great job exposing this topic!

Schwab has $269.5 billion of deposits with an average cost of only 1.35%! I am dumbfounded at the fact they have kept the cost of these deposits so low given their customers should be of an investor mindset, and even if a customer is primarily trading stocks they should still be focused on what their cash is earning.

As you point out, I've heard from others that it isn't so clear to see or know what your cash is earning (or not earning in this case!). My sister-in-law was getting hosed on a decent cash balance and said she couldn't find the rate anywhere, so she eventually called to have her cash moved into a money market but, like you, it sat in their low-yielding product for way too long.

Now that we are in a "higher-for-longer" environment, it is just a matter of time before those deposit costs move meaningfully higher, particularly as more people like you start realizing you've been taken advantage of. The average cost of deposits in the banking industry is likely going to be near 2.5% after all the Q1 reports are filed, and I would say the banking industry should have a lower cost of deposits than Schwab given traditional banks have more non-interest bearing/transaction deposits.

To put this into perspective, Schwab – the entire company – is expected to earn around $6.2 billion in 2024. The management is very promotional and acts like their cost of deposits could potentially decline if there are rate cuts, which I strongly disagree with. You can easily do the math... if their cost of deposits only goes up by only 1%, that is a pre-tax cost of $2.7 billion! (And if the higher-for-longer environment persists for several years, it wouldn't surprise me to see the Schwab deposits move materially higher than a 1% increase.)

Even if SCHW can achieve these earnings estimates, the stock is trading at over 21 times earnings. And analysts are expecting earnings to grow 28% in 2025 to $4.37/share. I really struggle to see how they can grow earnings at all amidst this dynamic.

As he continues, the cost of deposits is just one of the issues caused by the higher-for-longer environment:

Schwab's bank is one of the worst in the industry when it comes to fair value marks. They have not filed their 10Q and bank call report yet for Q1, but I estimate that their held-to-maturity securities mark is roughly $14.6 billion and their loan portfolio mark is roughly $1.9 billion (both tax-adjusted), which would leave them with negative tangible common equity of over $3.7 billion (they currently have stated tangible common equity of only $12.8 billion)!

If the regulators (or investors) decide to refocus on the fair value issues that sunk Silicon Valley Bank and First Republic, then it would be impossible for Schwab to avoid scrutiny as it is the 11th largest bank in the country. If I were the regulator, I would force Schwab Bank to immediately raise a significant amount of capital.

If you are wondering why they have these massive interest rate marks, they basically took in large amounts of low-cost deposits that they thought would be cheap forever, so like most banks they went out and bought securities (primarily RMBS [residential mortgage-backed securities] and CMBS [commercial mortgage-backed securities]) to capture some spread. Schwab's securities portfolio yields less than 2%, so as their deposit costs rise they could have a big portion of their balance sheet with a negative spread.

Here is the bank call report data from 12/31/23 (note that the $11.2 billion held-to-maturity loss was at 12/31). I am estimating the securities are worth 88 cents on the dollar in coming up with my current $14.6 billion mark.

In addition to buying the low-yielding securities, Schwab took on $9.35 billion of 1-4 family mortgages that are yielding in the 3% range! That is the driver of the nearly $2 billion tax-adjusted loan mark.

For sake of full disclosure, I am short the stock, but regardless thought you would find this summary interesting given I would say it is just a matter of time before more people like you wake up to the fact that as you put it: "Schwab is screwing you over in the same way banks are screwing their customers who are holding cash in their savings accounts."

Not only will Schwab's interest expense skyrocket, but I think they have reputational risk as customers could easily be soured after learning they've been burglarized by the company over the past couple of years.

I'd like to give a huge thank you to my friends and readers for taking the time to share your thoughts!

When it comes to Schwab's stock, I agree that it looks like one to avoid.

(For the sake of additional disclosure when it comes to brokers, I'll note that my company Stansberry Research does not recommend or endorse any brokers, dealers, or investment advisers. We are not affiliated with any brokerage and do not receive any compensation for mentioning a particular firm.)

Best regards,

Whitney

P.S. I welcome your feedback – send me an e-mail by clicking here.