How To Pick A Robo-Advisor In The Digital Wealth Management Era

Old Coins by Financial SamuraiOne of the reasons why I’m an Apple user is because I appreciate good service. When I dropped my Macbook one evening and my hard drive stopped working, it was incredibly easy to schedule an appointment with the Genius Bar at my local Apple store. They fixed my hard drive and recovered my data within 30 minutes and away I went. Peace of mind is worth the premium, which is why I’m a fan of technology-assisted financial advisory firms with human financial advisors.

But what if you have time and know how to upgrade your RAM, swap out your hard drive, and do your own diagnostics? (I remember doing all that as a teenager.) Then going the robo-advisor route may very well be a good option because their fees are even lower. There’s just no person to guide you through life’s myriad changes.

Robo-advisors, aka algorithmic advisors deploy sophisticated investment algorithms to help invest your money in the best risk-adjusted way possible. You essentially fill out a profile about yourself and the algorithm will go to work to recommend and implement their recommendations for you.

I used to have a hard time trusting computers to do anything for me. But after spending 13 years covering some of the largest mutual funds and hedge funds in America, it’s clear that algorithmic investing, or more commonly known as quantitative investing or scientific investing have done extremely well. For example, Bridgewater Associates run by Ray Dalio is the largest hedge fund in the world with over $120 billion dollars and it’s a macro quantitative fund with tremendous performance. Famous hedge funds run by George Soros, David Tepper, and Steve A. Cohen can’t even compare.

A good quant fund or algorithmic advisor is all about having good people. At the end of the day, the investment variables are created by people and continuously tested for maximum returns. Spending time understanding people’s backgrounds and then trusting them to do the right thing is a huge part of letting other people run your money. After all, the reason why you want someone else investing your money is because your expertise lies elsewhere, and you’ve got more interesting things to do with your time.

In this article, I’d like to provide a brief primer on the three main robo-advisors that exist today: FutureAdvisor, Betterment, and Wealthfront. Because I’ve personally met Bo Lu, Founder of FutureAdvisor, I’m going to compare and contrast FutureAdvisor to the other two. They are all based here in San Francisco.

Target-Date Fund Investing

The core offering by robo-advisors is very similar to investing in a target-date fund. A target-date fund works by taking your desired retirement age (without taking into account risk appetite), and slowly shifting your stock/bond split more heavily to bonds as you approach your retirement date.

Wealthfront and Betterment need investors to transfer over their assets in order to create those target-date fund accounts, and they can only see the assets they hold. Once you give them your assets, they allocate them to create a balanced portfolio, but only within that account. That’s a valuable service, but for investors with multiple accounts already, it may not be the right solution.

Wealthfront charges 0.25% of your assets, Betterment charges up to 0.35% and FutureAdvisor is free if you want to DIY or charges 0.5% of your assets to manage your money. Vanguard’s target-date funds charge 0.17%. The expense ratio for Wells Fargo’s index-based target-date funds ranges from an average of 0.35% to 1.63% per year. For the two classes of Fidelity’s actively managed Freedom funds, the average annual expense ratios are 0.57% and 0.60%.

A Top Down View Of Your Overall Finances

In order to get a balanced recommendation for your investment portfolio, it’s important for the robo-advisor to see what your overall financial picture looks like. For example, let’s say you own a lot of real estate like I do (~35% of my net worth). It doesn’t look like you can input such assets to be considered in Betterment and Wealthfront’s investment algorithms. They can only provide recommendations on what you give them.

If you believe in modern portfolio theory, then you have to assume that combining Betterment or Wealthfront with external assets will lead to an unbalanced overall portfolio, and investors will pay the price in risk or rewards.

Furthermore, more sophisticated investors with several accounts may not want to liquidate their accounts for a target-date fund. It involves paperwork, the transactions will be taxed, and moving your assets to a startup implies a certain risk.

HOW FUTUREADVISOR IS DIFFERENT

FutureAdvisor goes to your assets, wherever they are, instead of you having to bring your assets to them. This is a huge competitive advantage and selling point in my mind because I dislike paperwork and the process of transferring assets.

FutureAdvisor works with thousands of brokerage accounts and IRAs to provide free financial advice. They provide step-by-step instructions showing you what to buy and sell across all your accounts to achieve a risk-adjusted balanced portfolio.

Wealthfront and Betterment don’t offer that free and actionable advice, and they can’t see assets outside of the accounts you create with them.

FutureAdvisor’s premium service will balance your portfolio for you based on the recommendations its algorithm produces. In other words, if you become a client (minimum is $10,000) they will execute your trades for free, which is included in their 50 bps annual fee based off your assets.

FutureAdvisor can directly manage accounts held at Fidelity and TDAmeritrade because they have partnerships with both. Fidelity and TDAmeritrade have millions of accounts and run over a trillion dollars in assets. Chances are you already work with one of them. I had my 401k with Fidelity for 13 years until I rolled it over to a Rollover IRA. Fidelity also holds my SEP IRA and solo 401k as well. Having easy transitions when it comes to someone managing your money is huge.

Wealthfront and Betterment need your assets to go to their algorithms. FutureAdvisor sends its algorithms to your assets. The difference is convenience.

DEEPER TAX-LOSS HARVESTING

All three services do tax-loss harvesting, but they do it in different ways. Betterment and Wealthfront conduct tax-loss harvesting on the assets you’ve given them from the moment you create an account. They handle future losses.

Because FutureAdvisor can handle all your assets where they are, they conduct tax-loss harvesting on all your losses historically, which can amount to a much larger amount that you can deduct from your taxes.

Accounts at any other brokerage can be moved to Fidelity or TDAmeritrade without a tax hit. It’s called a “transfer in kind,” and it means you don’t have to sell what you have and buy something else. This approach logically seems better since it looks at your overall wealth.

FREE 401K ADVICE

Since none of the robo-advisors can actively manage money in a 401k, the majority just ignore it. FutureAdvisor, on the other hand, looks at your entire portfolio holistically. They manage around your 401k with the assets you choose to give them, and also show you how to cut fees and rebalance within your portfolio (without charging on the assets in the 401k). It’s the extra step that makes sure you have a fully diversified portfolio – not just a single diversified account.

Given that 401(k)s account for most of Americans’ retirement savings, FutureAdvisor’s ability to work with them makes it much more valuable.

THE TYPICAL FUTUREADVISOR CLIENT

After speaking with Bo (CEO), I discovered that the average FutureAdvisor client has saved more than $100,000. They already have brokerage accounts and IRAs, and they don’t want to liquidate them. They want someone who will tell them how to invest better given what they have. This is where FutureAdvisor’s algorithms come in.

After you create an account with your email, FutureAdvisor provides you with a target portfolio based on your age, retirement year and risk tolerance. In the following slides, I’ll show you exactly what I went through so you can get a better idea of the robo-advisory process.

Section #1: Info Gathering

Simply fill out your basic information so that FutureAdvisor’s algorithms can formulate a plan. Be as honest as possible, because quality outputs depend on quality inputs.

Robo Advisor Chart

Section #2: Interactive Score Card

After you’ve filled out your basic info, you link your current investment accounts to get an interactive score card, with step-by-step instructions on how to change your current portfolio to reach your objectives. You get instructions for each account, and an explanation of why they’re suggesting what. It’s all about customization based on your own risk-tolerance and input variables.

Robo Advisor Chart

Robo Advisor Chart

Section #3: Specific Recommendations 

The slide below shows the specific recommendations from FutureAdvisor’s algorithms instead of more general recommendations. I really like how they go through each security and analyze what you should do and why. If you’re a detailed-oriented person like me, this feature is terrific.

Robo Advisor Chart

Robo Advisor

Section #4: The Results

The final chart shows exactly how FutureAdvisor will convert your suboptimal portfolio into an “A” portfolio across the board immediately. If you’re using the free service it can be done whenever the markets are open, if you’re using the Premium service the paperwork will take a few business days to complete.FutureAdvisor Portfolio Optimization

FutureAdvisor Dashboard

MORE ABOUT THE ALGORITHMS

The algorithms FutureAdvisor have are built on data going back over a 100 years where available. Their back testing has been done in some of the most extreme financial corrections and have held up well so far. For example, for 2014 through the end of June FutureAdvisor is ahead of the S&P 500 by +1.65% for the average FutureAdvisor account. Of course, past performance is not indicative of future results.

FutureAdvisor’s algorithms seek out commission-free ETFs within your broker to eliminate trading costs. iShares funds trade commission free at Fidelity and TD Ameritrade has 100s of commission free ETFs, as two examples.  Since they aren’t trading underlying equities, trading costs are rarely if ever an issue.

FutureAdvisor has a team of seasoned CFAs and PhDs who create and maintain the algorithms as well as an academic council who help inform us of financial developments. Simon Moore, CFA, MBA our Chief Investment Officer is an economics graduate from Oxford University and published author.

CONCLUSION

For the DIY investor, FutureAdvisor’s free tools and recommendations provide a good second recommendation and sanity check for your investment decisions. A lot of times you might think your level of risk exposure is appropriate with your risk tolerance, but often times you’ll be wrong. The good thing about an algorithm is that there is no bias. It will unabashedly tell you what it thinks you should do to become better aligned with your objectives. Then it’s up to you to figure out whether to take its advice or not. Perhaps your investments already have a “B or “A” grade based on their algorithms and you won’t have to do much at all. You won’t know until you try.

If you don’t want to handle the transactions yourself, FutureAdvisor can manage your money for 0.5% of assets per year with a minimum commitment of $10,000. They automatically rebalance, optimize for taxes and can auto-invest new cash when added. Their goal is to get your Performance, Diversification, Fee Efficiency, and Tax Efficiency all to an “A” grade. I’m sure the other robo-advisors are good as well. But I like to discuss what I know based off the people I’ve met.

FutureAdvisor is backed by Sequoia Capital and angel investors which include Keith Rabois, the chief operating officer at Square, and Yelp founder Jeremy Stoppelman. It’s a small world because after I played tennis with Bo Lu, the CEO of FutureAdvisor at my club, I played tennis with Jeremy just a couple weeks later and he brought up the fact that he is an early investor in Bo’s company.

Sam started Financial Samurai in 2009 during the depths of the financial crisis as a way to make sense of chaos. After 13 years working on Wall Street, Sam decided to retire in 2012 to utilize everything he learned in business school to focus on online entrepreneurship.

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Comments

  1. says

    Great article. Admittedly, it’s definitely something I wish I knew more about. I still have a hard time handing off my investment decisions to someone else (even a financial adviser/planner) but the day is coming when I’ll have to I assume. Optimizing for taxes is also something I haven’t really been worried about but as the value of my portfolio grows, I really should start.

    Jay

  2. Joe I says

    That’s pretty neat FutureAdvisor goes to the client instead of having to port all your assets to them. But how do they actually make the trades and rebalance for you if all your assets are still with you? Do you give them a right to trade on your behalf?

    I like their free grade report and optimization / recommendation analysis.

    • says

      Hi Joe – We take limited trading control of your accounts which lets us make the trades and balances on your behalf. Since we custodian with TD and Fidelity, it makes for a pretty simple process if you’re already using them!

      • AI says

        What is the process if you don’t have an account with TD and Fidelity? Is it all done online where you would gain access to my E*TRADE account, for example? How long does the process take?

        thx

        • says

          We’d have to have you open an account with Fidelity (which is part of our internal process) but then we’d transfer the assets in-kind from e-trade (no need for liquidation, and the account is in your name not ours). All the paperwork can be signed electronically, and the transfer to the Fidelity account would take 5-7 business days.

          Let me know if that makes sense!

  3. says

    I don’t use a robo-advisor, but admittedly I had no idea there was something this sophisticated out there – FutureAdvisor looks amazing from what you’ve shown above! Getting a cold, hard opinion on your risk exposure would be pretty valuable – I know I often mistakenly assume my portfolio is ‘safe’ just because I’m confident about each individual investment.

    Shame they don’t cater for Australian residents – I’d definitely be keen to give it a trial.

  4. Ricky says

    An intense amount of work obviously went into this article. I commend you for that.

    I must admit that even though I am still a proponent for Vanguard funds for those that prefer an off-hands approach, I am still impressed by the affordability of these new-ish online advisors. You’re paying more than if you did the research yourself, but you’re also getting better tools for analysis I suppose.

    • says

      I’m still consulting for PC. FutureAdvisor is a algorithmic only advisor with no human advisors. Personal Capital is often incorrectly grouped in the Robo-advisor category as they employee a team of human financial advisors in SF and Denver. PC’s minimum is $100,000. FA’s minimum is $10,000. A slightly different demographic, although PC’s app is free for all to use.

  5. Brian says

    Interesting article. However, I don’t really get the point of using a robo-advisor. If the goal is to essentially create a target-date fund why not just get a vanguard target date fund and save on the costs of the middle man? FA actually sounds decent since it takes into consideration your 401k. Majority of Americans don’t invest/save more than $17500 a year so Betterment and Wealthfront seem to be completely pointless to most. FA is also nice since it would eliminate the need for them to con clients into investing outside their 401k, if the get paid advising that too.

    It must do a great job at finding cheap funds to get 12 assets classes on 360k portfolio to 0.15% ER. I would assume all index? But in your case does it really make sense to switch from a 0.22% to a 0.15% + 0.5%? I’m pretty sure you knew that your portfolio wasn’t diversified and didn’t need a robo-investor to tell you that.

    I also think their claim that to have beat the S&P 500 interesting. Must have more young investors than old with a low % of bonds. Be interesting how long they can make that claim for.

    I guess if your really want to take no part in your investments/savings than FA is probably one of the better options out there.

    By the way what’s your USTA rating?

  6. says

    This seems like a good use of technology. Why not use what computers do very well. Using an algorithm to help you better manage your investments sounds good if you know what to do with the information. The more information the better.

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