One 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 benefits of using a robo-advisor to manage your money. There are two main robo-advisors that exist today: Wealthfront and Betterment. My focus will be on Wealthfront as they are based right here in the SF Bay Area and started first.
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 needs 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 over the first 15K. Wealthfront manages about $2.5 billion of client’s money and generally targets the more sophisticated investor. They’ve since lowered their minimum to $500, and the first $10,000 managed is free. This is pretty huge for investors who just want to try things out at no cost.
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).
If you believe in modern portfolio theory, then it’s important to take into account the other parts of your net worth when filling out Wealthfront’s simple questionnaire in the beginning for them to assess what type of portfolio they will construct based on your answers.
Here’s a sample portfolio that Wealthfront will create for me after inputting my answers. I’m a relatively high risk tolerant investor who is happy to buy more stocks if there is a 10% price correction.
DEEPER TAX-LOSS HARVESTING
All three services do tax-loss harvesting, but they do it in different ways. Wealthfront conducts 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. Wealthfront, 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.
MORE ABOUT THE ALGORITHMS
The algorithms Wealthfront 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.
Wealthfront’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.
Wealthfront 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.
ROBO ADVISORS ARE HERE TO STAY
Wealthfront is an excellent choice for those who want the lowest fees and can’t be bothered with actively managing their money themselves once they’ve gone through the discovery process. In the long run, it is very hard to outperform any index, therefore, the key is to pay the lowest fees possible while being invested in the market.
Wealthfront charges $0 in fees for the first $15,000 using my special invite link, only 0.25% for any money over $15,000, and only have a $500 minimum to get started. Invest your idle money cheaply, instead of letting it lose purchasing power due to inflation. You don’t even need to fund your account to see what type of portfolio they’ll construct for you based off your risk tolerance.
About the Author: Sam began investing his own money ever since he opened an online brokerage account online in 1995. Sam loved investing so much that he decided to make a career out of investing by spending the next 13 years after college working at Goldman Sachs and Credit Suisse Group. During this time, Sam received his MBA from UC Berkeley with a focus on finance and real estate. He also became Series 7 and Series 63 registered. In 2012, Sam was able to retire at the age of 34 largely due to his investments that now generate roughly $200,000 a year in passive income. He spends time playing tennis, hanging out with family, consulting for leading fintech companies in the Bay Area.
Updated for 2017 and beyond. Robo-advisor FutureAdvisor was acquired by Blackrock in 2015, so it’s mainly Wealthfront that is leading the charge with over $3B in assets under management as of 1H2017.