Thinking About Custodians

I hope your week is going well so far. It’s a busy one on my side of things with big companies reporting earnings and the Fed meeting again tomorrow. Bond investors are pricing in a 99% chance the Fed will raise interest rates yet again, so no midsummer slowdown anytime soon.

Additionally, we keep edging closer to the date when Schwab fully absorbs the custodian I’ve been using for nearly ten years, TD Ameritrade. Some of my clients have been asking good questions about this so I thought I’d broaden my responses to include all of you. Maybe it’s too much inside baseball, but this information could provide some understanding of how my industry is structured and how that applies to you even if we’re not managing your investments.

As you may recall, Schwab announced its deal to buy TD Ameritrade way back in 2019. They got the required regulatory approval and planned to start absorbing TD the following year. Then the pandemic hit. Markets and investors went crazy for a while and that blended with myriad other issues to make Schwab push the pause button on merging the two companies and didn’t press play until earlier this year. The final push to integrate the two companies is set for this coming Labor Day weekend, and then what’s been ruefully referred to as Schwabitrade will move forward and TD Ameritrade will be no more.

Let’s look at the current custodial landscape a bit. TD Ameritrade, Schwab, and other firms like Fidelity and Vanguard are good examples of large custodians that serve a fundamental role in my industry and in your financial future as well. They’re custodians of your cash and investments. They’re responsible for keeping your assets safe from theft and fraudulent activity. They process your transactions while keeping track of everything so they (and you) can report that activity to the IRS. They also maintain the structure that lets firms like mine access your accounts, place trade orders, move money to your checking account, and so forth. In short, you couldn’t invest like you do today without a good custodian operating largely in the background. It would be too expensive and risky, as the victims of privately-held investment fraud and Ponzi schemes would grudgingly attest.

The role of custodian has become highly commoditized following Schwab and its main competitors “going to zero” in 2019, which meant they would no longer charge trade fees on the bulk of transactions they processed. This reshuffled the industry and helped fuel a wave of consolidation that we’re dealing with even today. Now the large custodians look very similar to each other and the differences between them are deep in the weeds. As with the big banks and other industries, personal and expert service has given way to impersonal subpar service and a reliance on automation.

So how do you know if you’re at the “right” custodian and how did I, as a fiduciary and “decider” on behalf of my clients, make the choice to merge into Schwab?

As I just mentioned, the big custodians are very similar in the fundamental services they offer. Where they differ has more to do with how you’ll be interacting with them and if you require special services, such as with advanced trading strategies or perhaps holding illiquid investments. There are smaller and boutique custodians that specialize in these areas, but I argue that they’re not for the typical retail investor.

Assuming you’re not interested in these sorts of special use cases, it’s almost a coin flip as to which of the major custodians is best. Here are some of the high points for comparison as they will all offer:

Structural security. Each of your accounts is owned by you even though the account is held by the custodian. Your accounts aren’t comingled and, even if the custodian failed, your accounts wouldn’t be directly impacted. This is an important distinction that I’m asked about frequently, especially in the context of recent bank failures.

Insurance coverage on deposits. Each custodian provides coverage against bankruptcy and fraud or theft at the firm itself up to $500,000 through the Securities Investor Protection Corp and excess coverage through Lloyds of London. These custodians also offer FDIC coverage on cash deposits with their bank or perhaps with an affiliate bank. And for clarity, none of this coverage protects you from losing money on your investments – it’s just about risk of the custodian running into trouble.

A modern website and app. These are table stakes and the large custodians each do this well. Who has a better website or iPhone app? It’s entirely personal preference since you’ll be able to do the same essential things on whichever platform you choose.

Generally poor service with a reliance on digital and automation. Like with the big banks, the service quality you receive depends on who picks up the phone. But how often do you need to interact with them via phone or even in person anyway? Most of the time you’ll rely on their technology and how easy it is to use. Again, I think who is best here is all about personal preference. No large custodians consistently demonstrate great service – it’s the unfortunate reality of the time. Maybe AI helps with this but otherwise they’re all in the same boat for the foreseeable future.

Transferability of your data. I’ve mentioned how the custodians track and store your account data. A positive offshoot of this is being able to move all of that data electronically to another custodian. This is usually handled through the ACAT system, a regulated electronic transfer process that frees you to move between custodians without having to worry about adverse tax consequences or losing your historical data.

A few things the custodians don’t do:

They store your historical data but don’t provide detailed performance reporting. I have to pay a third party to verify client data from the custodian and then independently calculate performance. The custodians could do this themselves and perhaps charge for it, but none do.

They don’t provide investment advice or management services unless you pay for it separately. “Freemium” services abound but none are actually free.

They don’t operate as a non-profit organization. These companies absolutely have a profit motive and squeeze you in multiple ways, even while not charging you for most transactions. They push your cash into their own bank and proprietary funds, or both. They often sell your trade orders to the highest bidder. They consistently try upselling you to expensive products and services. And yes, they do all this while breathlessly telling you how they’re looking out for your best interests.

So again, your choice between the large custodians is all about personal preference since in most ways they’re nearly identical. Take your pick and you can move to another if necessary. You always need to be wary of cost, direct and indirect, but that’s true pretty much everywhere.

How did I choose to allow the upcoming move from TD to Schwab? In short, the other large custodians aren’t different enough from Schwab to justify the move and, among smaller or boutique custodians that cater to firms like mine, there wasn’t enough of a difference either. And in some cases the smaller firms are too new and would indirectly cost my clients money by limiting choice. That’s unacceptable for all the reasons you can imagine. And one solid prospect was bought by an upstart earlier this year as part of the industry consolidation already mentioned. C’est la vie, right?

Am I entirely happy about the move to Schwab? No, because I used to work there and don’t particularly like the culture, but that doesn’t directly impact how well they do their fundamental job of custodian. Maybe the ideal custodian will materialize out of all this someday, but that’s not likely anytime soon. Until then, Schwab presents the best combination of options in an environment that I feel I can successfully navigate on behalf of my clients.

Have questions? Ask us. We can help.