Schwab Fact Check

In the web documentation for the new Schwab Intelligent Portfolios (SIP), there were a couple of contentions that seemed counter intuitive. So I decided to check them out for myself.

The first was in the white paper on “Asset Allocation”. The contention was that with asset allocation the result was “More than the sum of the parts”. Their example included $100 invested in the S&P 500, $100 invested in gold, and a 50/50 split. The period was 1971 to 2014. During that period, the 50/50 split performed better. I wanted to know if that were true for other periods.

So I downloaded monthly data starting in 1993. Instead of just the S&P 500 Index, I used the SPY ETF and re-invested the dividends. I simulated holding the investments for 10 years. This resulted in 144 10 year intervals starting in 2003. The 50/50 approach lagged the best performing of the other two alternatives in each interval, but was ahead of the worst performing. Had you picked gold, the 50/50 approach would only beat you about 1/3^rd of the time. But I probably would have picked SPY and been wrong 2/3^rd of the time. So I concluded that their contention was true.

The second contention was in the white paper “The Role of Cash Investments in Asset Allocation”.  Their primary arguments were that cash provided some stability and reduced downside risk. But they also argued that cash is good for inflation protection.  That also seemed counter intuitive to me. But Schwab indicated that the interest rate you receive is tied to a short term interest rate index that has a high correlation to inflation.

So I downloaded consumer price index (CPI) and interest rate data for the period of 2002 to 2014. When I ran correlation, I was surprised not finding a high positive correlation between the CPI and interest rates. In fact, there was a negative correlation. Then it occurred to me that it wasn’t the rate that was important, but the impact it had on the cash in the account. I built a column that started with $100 and added the interest earned monthly. This correlated very highly with the CPI.  So again I concluded that this contention was true.

As an aside, gold had about the highest correlation to the CPI. So if you want inflation protection, gold needs to be an asset in your portfolio. Hopefully I’ll be adding the SIP test account to my weekend post. Follow me on Twitter @billlanke and I’ll let you know when I make that post.