Should You Be Using a Robo-Advisor?

Robot icon

Would you trust this little guy with your retirement? 🙂

In 2010, I found myself attending the Finovate Fall event in New York City. Even though I’d been a personal finance blogger for over five years, I hadn’t heard of so many of the companies presenting.

I took a lot of meetings those couple days including one with a young guy planning on changing the investing world. His name was Jon and I met him in a small coffeehouse near the conference. I had met with so many other companies up to that point, so many payments companies actually, that I don’t think I really fully appreciated what he was trying to do. He was a sharp guy with a great plan, a strong team, and a little funding behind them. I left thinking they’d do big things and that Jon looked a little like Justin Timberlake with longer hair. 🙂

Turns out they would!

Today, Jon Stein is the CEO of Betterment, a robo-advisor with over $13.5 billion in assets under management. It’s only a matter of time for them. 🙂

Many folks are now comfortable with the idea of robo-advisors now. Back then, the road ahead was less certain. If you wanted investment help, you had to pay a lot for the pleasure. Or you could go it alone with low-cost funds and ETFs. That’s the route I went – my investments are still in a mix of Vanguard funds and individual holdings.

If you’re new or you’re merely unsure how to proceed, you might be wondering if a robo-advisor can help you make better investing decisions?

Are you wondering if it’s worth paying yet another fee to another company?

I hope we can answer that.

Why You Should Use a Robo Advisor

Most people interested in roboadvisors know the benefits, but we’ll touch on a few here and then dig deeper when we talk about specific roboadvisors as we talk about their offerings.

1. Automatic is Effective

Human beings are notoriously bad at investing. We are emotional (sell low, buy high!), we forget, and we are otherwise very fallible.

One of the biggest benefits of roboadvisors is that it automates the investing process in a way that helps us. You can set the amount you save, the system can put it in the right allocations, and you can practically walk away and rest assured knowing your investments are properly allocated based on the answers in your questionnaire.

These robots don’t sell in a panic, don’t forget to make contributions or rebalance, and will even harvest tax losses to keep you as efficient as possible.

2. Fees Are Reasonable

Most of the robo-advisors will charge half a percent or less on assets under management, which is far less than an actual financial advisor who manages assets.

Most experts recommend that you only work with fee-only financial advisors but the ones who run their own funds will often charge 1% or more. The benefit of a roboadvisor is that it’s a computer and computers don’t have families to feed.

3. “Light” financial planning

Many of the roboadvisors will establish an asset allocation based on a series of question, which I consider “light” financial planning. It’s not an all-inclusive process but it’s a way for them to codify their approach in an automated fashion so that you can capture some of that expertise without paying through the nose.

Financial planning is not rocket science and you can build a financial plan without a professional financial planner. For many people and situations, it’s not unlike doing your taxes with TurboTax.

If you are just starting out and have $2,000 you want to put to work, paying someone $200 an hour to come up with a full plan chops a solid 10% of your nest egg right off the bat. A plan is important but a robo-advisor can get you invested (and more importantly, saving towards something) and that’s literally more than half the battle. The number one reason why people aren’t prepared for retirement is that they simply are not saving enough.

4. Low or No Minimums

Many roboadvisors have low or no minimum account balances, which means someone just getting into the investing game can take $100 and get it in a diversified portfolio. Many target retirement funds have minimums (Vanguard is $1,000, Fidelity is $2500) that may be too high for new investors.

Betterment and Wealthsimple have no minimum (or $1). Wealthfront has a $500 minimum. They’re much lower than a fund.

(here is a full review of Wealthsimple)

A low minimum is good because it gets you in the habit of investing early and investing early is crucial.

Why You Should NOT Use a Robo Advisor

Roboadvisors are popular but there are reasons why you don’t need them.

1. You Can Do It Yourself

100% you can do this yourself.

Here are two ways:

  1. Fire up a retirement calculator or your favorite asset allocation tool and just buy what it tells you from a low-cost provider like Vanguard or Fidelity. Then remember to check your asset allocations and rebalance on an annual basis, so your allocations aren’t out of what. It’s not hard.
  2. If that sounds hard, you can always invest in a target-date retirement fund and have that fund take care of all your issues for you. It’s not as customized a solution as a calculator but it’s pretty cheap (you do pay an expense ratio on the fund, which is often on top of the underlying funds’ fees). If you want to retire in 2040, but a fund with a target date of 2040 – it’s that easy!

Roboadvisors offer something in between the DIY and the one-size-fits-all approach. You still have to provide the answers to the calculators, but they can do a lot of the heavy lifting on your behalf.

Nothing stops you from doing it all yourself… the question you have to ask yourself is: Will you? Only you know.

When was the last time you rebalanced your portfolio? Analyzed your asset allocation? Or sell a loser so you can harvest those losses for tax purposes?

Robo-advisors have flourished because a lot of people don’t.

2. Robots Aren’t Magic

Many people are very satisfied with their roboadvisors because they’ve existed in a bull market. Betterment and Wealthfront were both founded in 2008. The S&P hit a low in spring of 2009, so most accountholders have only seen the S&P500 go up up up.

If you only look at your account balance and returns, roboadvisors seem amazing! But they’re just a flashy new ship in a rising tide – they look good because everyone looks good. Don’t let that fool you.

Robo-advisors do not have a magic formula. They simply exist in a financial area where the users don’t have enough money to make a financial advisor “worth it” and mixes a bit of DIY with automation to create a solution that is relatively low cost but effective. The mix they recommend is not magic, it’s simply an allocation that seems prudent based on your financial situation.

You are paying for automation.

3. It’s the Fees That’ll Drain You

Along the lines of being able to do it yourself, why pay someone else to tell you an asset allocation you can figure out with a calculator?

Half a percent doesn’t sound like a lot but project it over decades and the difference is huge.

I’ll spare you the detailed math but the difference between a return of 8% and 8.5% on a single $1,000 investment is $1,495.

The math assumes a single $1,000 investment in the first year, with no additional contributions, that compounds annually at 8.5% or 8.0%. It’s in a tax-deferred account, so we can ignore the impact of taxes, but after 30 years the 8.5% return is worth $11,558 and the 8.0% is worth $10,063. A difference of $1,495.

That said, while $1495 looks like a lot, you might be tempted to calculate it as only $50 a year. But that’s $50 on just a thousand bucks of investment made once. You can imagine how that gets worse as the numbers get bigger.

Take that same scenario but now you make $1,000 contributions each year, the difference is now $12,427 ($135,773 vs. $123,346).

That’s a lot in lost gains due to the fees.

4. Not 100% Personalized

One of the Pros is that it’s “light” financial planning – it shouldn’t replace actual financial planning.

Many of the roboadvisors provide an allocation after you answer a short questionnaire. That questionnaire isn’t part of an entire financial plan with all of your goals. When do you want to buy a house? How about kids? What about continuing education or investments in other aspects of your life? You have funding needs that cannot be captured in any standard questionnaire given to everyone.

So while they promise personalization, it’s more like categorization. Which asset allocation bucket do you fall into? That’s a good place to start but it’s difficult for you to be optimized if you never progress beyond that.

All that being said, I’m bullish on roboadvisors. Let’s take a look at some of their offerings.

Betterment

Founded in 2010, they now manage $13.5 billion as of March 2018.

Betterment was one of the first roboadvisors (heck, before they were even called roboadvisors). They rely on a personalized strategy called “goal-based investing” which builds a portfolio based on your profile and your answers to their questions. They will manage your assets but also give you advice based on external bank and brokerage accounts, which you can link to your Betterment account.

The portfolios rely on ETFs (exchange-traded funds) from Vanguard, iShares, and other similarly structured low-cost funds.

They support individual taxable accounts, Traditional IRAs, Roth IRAs, and SEP IRAs.

There are two pricing tiers:

  • Digital tier: 0.25% annual fee with no minimum
  • Premium tier: 0.40% annual fee with a $100,000 minimum

The Digital tier gives you access to all their tools and investment portfolios plus automatic rebalancing so you maintain their suggested asset allocation. It also includes automatic tax-loss harvesting and asset location management (to increase after-tax returns).

The Premium tier adds onto the Digital with in-depth advice on investments outside of Betterment plus unlimited access to CFP professionals for advice on life events like marriage, children, employer stock options, retirement, etc.

We have a comprehensive review of Betterment if you’d like to learn more.

Learn more about Betterment

Schwab’s Intelligent Portfolios

Charles Schwab is an old name but a relative newcomer to the roboadvisor world. What’s compelling about their Intelligent Portfolio is that they are free. There are no account fees and no commissions because they put in you Charles Schwab ETFs, where they earn their money. This is Charles Schwab’s foray into becoming a robo-advisor.

This is a little like Vanguard’s Target Date funds and Fidelity’s Freedom Funds – those funds are “All-in-one funds” that hold other Vanguard and Fidelity Funds. The idea behind these target retirement funds is that their mix of investments changes over time, all aiming at the retirement age of the fund. If you want to retire in 2045, buy the 2045 fund. Those all-in-one funds have their own expense ratios, 0.15% for Vanguard’s Target Retirement 2045 fund and 0.75% for Fidelity Freedom 2045 Fund, on top of the underlying fund fees.

Schwab has their own target-date funds, so the Intelligent Portfolios are simply a more closely tailored approach. You are asked to complete a questionnaire, which constructs a goal-based portfolio, and there’s automatic rebalancing and tax loss harvesting if your account is greater than $50,000. The minimum to open is $5,000.

Are Charles Schwab’s Intelligent Portfolios really free? Sadly, no. Schwab makes its money on the cash portion of your account. The “Cash Allocation” will be 6-30% of your portfolio and earns a modest interest rate (currently 0.52% APY).

Wealthsimple

Wealthsimple got its start in Canada but is available north and south of the border. What separates them from the rest is they offer socially responsible investing options, including halal options to fit Islamic law. They also offer automatic rebalance and tax-loss harvesting to all account holders (not just the high dollar ones) and financial planners if the need exists.

The biggest “knock” against Wealthsimple is their relatively high management fee, which varies based on the tier:

  • Wealthsimple Basic ($0 – $100,000 in assets) – For a 0.5% fee, you get rebalancing, tax-loss harvesting, dividend reinvesting, a personalized portfolio and advice.
  • Wealthsimple Black ($100,000+ in assets) – For a 0.4% fee, you get everyting in Wealthsimple Basic plus increased tax efficiency, VIP airline lounge access, as well as goal based planning.

Let’s dig into some of those broad terms a bit. With Basic, you get a similar level of service to other robo-advisors at their basic tier. Rebalancing, tax-loss harvesting, and the like are all fairly standard.

With Black, you get a 0.1% break on the fee plus a financial planning piece with a Money Coach that seems more involved than simple question and answer via a phone call, email, or text. There’s also VIP airline lounge access via a complimentary Priority Pass membership for you plus one travel companion.

Learn more about Wealthsimple

Wealthfront

Wealthfront is probably one of the better known roboadvisors, currently managing around $10 billion as of March 2018. Their Chief Investment Officer is none other than Burton Malkiel, the famed author of “A Random Walk Down Wall Street,” so they have some heavy hitters on board.

Wealthfront (full review) has a $500 account minimum and fees are set at 0.25% of assets, which comes with free rebalancing and daily tax-loss harvesting on their taxable accounts. I don’t have a Wealthfront account but my friend Chris does so if you sign up, you get your first $5,000 managed for free (so does he!).

Learn more about Wealthfront

Personal Capital

I’ve written quite a bit about Personal Capital’s free financial dashboard and investment planning tools but not much about them as a robo-advisor. That’s because what they offer is slightly different than what the other robo-advisors offer. Rather than suggest an asset allocation based on a questionnaire, they actually have you sit down and talk to a financial advisor before any asset allocations are suggested. They have a little more insight into your financial situation, based on what accounts you link to the dashboard, so this is more scalable than with other robo-advisors.

The fees are higher, since there is less automation and more human interaction, and will vary based on the level of invested assets:

  • First $1M: 0.89%
  • First $3M: 0.79%
  • Next $2M: 0.69%
  • Next $5M: 0.59%
  • Next $10M: 0.49%

As you can see, the fees are higher. The other robo-advisors top out at half a percent, that’s what you’d pay with a few million at Personal Capital. It’s expensive but it’s probably to help pay for their awesome tools we get to use for free. 🙂

Learn more about Personal Capital
(We have a detailed review of Personal Capital’s features here.)

Another one worth checking out is Ellevest, which is designed specifically for women.

Whether a robo is right for you will depend on your situation, but you’ll know the answer after a little bit of homework.

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