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Hello again! It’s been awhile, hasn’t it? We first did the Investment Workshop in late 2017, and since then I’ve been inundated with emails saying how helpful it’s been (thanks everyone!), but one glaring question people keep asking me is: What about Robo-Advisors?
So I thought now would be a great time to address this by adding a section about them to the end of our existing Investing Workshop. While my own personal investing style is to do everything myself, I get that for some people managing their own portfolio on their own can be a bit overwhelming and they might need some help. So let’s see how a Robo-Advisor could potentially fit into someone’s financial life, shall we?
What is a Robo-Advisor?
When we first retired in 2015, there were basically two main ways that people managed their portfolios: A DIY approach using a low-cost discount brokerage like Questrade, or a fancy-pants financial advisor working at a major bank. Both approaches had their issues. DIY investing is, by nature, more complicated because it puts the onus of managing your money on you, the investor. If you mistype an ETF symbol and accidentally buy hundreds of thousands of dollars of the wrong stock, well then that’s your own damned fault.
On the other hand, the financial advisory industry is rife with issues itself. While the suit-wearing salesman might promise to make investing easy, it’s really common for financial advisors to either churn your portfolio in order to generate commissions for themselves, or load you up with high-fee actively managed mutual funds because they pay the advisor a sales commission. Finding a financial advisor that’s fully aligned with your interests and charges a reasonable fee is really hard.
So in that environment, the fin-tech industry did what every tech company tries to do: write an app for that.
Basically, they tried to automate the design and maintenance of an investment portfolio, replacing a highly-paid suit-wearing human with an algorithm. You log into the app, answer some basic questions about your finances and risk tolerance, and BOOM it creates a portfolio for you. And on top of that, by linking it to your bank account, this app could also automate the deposits, re-balancing, and maintenance of your portfolio. The idea was that once you set it up, saving up for retirement would be an automatic set-it-and-forget-it activity.
This was, from my perspective, an absolutely genius move. Many highly-skilled professions like doctors are hard to automate away because we, the customer, generally prefer a human making the decisions rather than a machine. Financial advisors are absolutely NOT one of these professions. After reading countless stories of fraudsters like Bernie Madoff making off with their clients’ retirement funds, our trust in humans managing our money is at an all-time low. Having a computer do it for us seems far safer. After all, it’s not like a computer can get hooked on cocaine and run off to Vegas with our money, right?
A few years later and the Robo-Advisory industry has absolutely exploded in popularity. There are now over 100 Robo-Advisory firms out there, and even the big investment firms have been forced to offer Robo-Advisory services to stay competitive, which I find absolutely hilarious.
So now here we are, in 2019, and Robo-Advisors have now matured from a fledgling idea being pioneered by a bunch of tech firms into a legitimate offering that has earned its place at the table in terms of ways to manage your investment portfolio.
Are Robo-Advisors Safe?
The biggest advantage of Robo-Advisors are that there’s no Bernie Madoff-like charlatan who can abscond with your money. But that doesn’t mean scams don’t exist. Some tech firm could, for example, just whip up a snazzy looking website, start taking people’s money, and still run off with it.
So to guard against this, you have to make sure whatever Robo-Advisor you use is properly registered with the financial regulators of your country, and more importantly, a member of an investor protection plan that covers your account in the case the company goes belly-up.
In the US, this is the Securities Investor Protection Corporation, or SIPC. In Canada, this is the Canadian Investor Protection Fund, or CIPF.
You also can’t just take the firm’s word for it that they’re a member. After all, anyone can claim they are! So before doing business with any Robo-Advisor, go to the investor protection plan’s website and search their member directory to make sure the Robo-Advisor is actually listed as a member.
This way, if some hacker takes the system down or the CEO steals everyone’s money causing the firm goes under, you’d get your money back.
Investor protection. Never leave home without it.
How Do They Make Money?
Generally, Robo-Advisors operate under an Assets-Under-Management model, meaning they take a percentage of your portfolio as payment each and every year.
But wait! Isn’t this the same thing as those high-fee funds that I warned about?
Well, sorta.
The fee IS charged the same way that a mutual fund does it, but it’s much, much lower. A really bad actively managed fund may charge 2%, and a human financial advisor may charge 1% to 2%, but a Robo-Advisor’s fees are typically in the 0.3% to 0.5% range. So yes, a Robo Advisor’s fee will absolutely result in a long-term drag on your portfolio performance versus doing it all yourself.
However, depending on where you live that fee may be tax deductible. In Canada, the fee is directly deductible, so if you’re earning in a high tax bracket you’ll actually get some of that fee back as a tax break, making your effective fee in the 0.2%-0.4% range. In the US, advisory fees are no longer deductible under the Tax Cuts and Jobs Act. Sorry 🙁
Who Should Use One?
The decision about whether to use a Robo-Advisor is less a question of math and more of a question of behaviour. If something is keeping you from investing your money, then a Robo-Advisor can be really useful in getting you “un-stuck” and start moving towards building your early retirement. So as an example…
Busy Professionals
I know plenty of people who WANT to start investing but they just don’t have the time. Now, most of the time, this is just a BS excuse, but in certain cases I kind of get it. Certain professions like doctors, lawyers, or entrepreneurs really are around-the-clock types of careers, and when the day finally draws to a close these people just don’t have the mental bandwidth to sit down and calculate their rebalancing transactions. As a result, they just keep putting it off forever. These people would benefit greatly from using a Robo-Advisor.
Nervous First Timers
Similarly, there are plenty of people out there who understand how to build an investment portfolio but are just too nervous to pull the trigger on the first buy. A Robo-Advisor would also really help in this case, since they kind of make the day-to-day decisions for you. Getting invested and paying a small fee is better than sitting paralyzed on the sidelines forever, after all!
However, in both of these cases, I should point out that just because you decide to use a Robo-Advisor, that doesn’t mean you’re locked to using one FOREVER. You could conceivably use one to get your portfolio started the first few years, and then when you’re comfortable enough to manage it on your own, transfer your money out to a discount brokerage. Just saying.
Who Should NOT Use One?
Lazy People.
A Robo-Advisor is NOT a substitute for knowing how to manage your money. That’s why I put this Robo-Advisor guide at the end of the Workshop rather than the beginning. Because I want people to go through the entire workshop and actually learn the material. Nobody cares more about your money than you do, and if you blindly rely on someone else, whether a human or an app, to take care of your money for you, you’re gonna get screwed.
Don’t use a Robo-Advisor as a crutch to make up for your lack of knowledge. Instead, take the time to learn and understand how all this money stuff works. Then, if you still decide you want to use a Robo-Advisor, use it as a set of training wheels instead to help you get started. Once you feel comfortable managing your money on your own, you can decide to keep using the Robo-Advisor if you find their fee is worth the benefits you get, or you can decide to graduate to DIY by transferring out to a discount brokerage.
Let’s Try One Out!
OK so with all that out of the way, who’s ready to try one out? I know I am! Stay tuned for our next article when we take one of these suckers out for a spin. It’s gonna be epic!
Continue onto the next article…
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Disclaimer: The views expressed is provided as a general source of information only and should not be considered to be personal investment advice or solicitation to buy or sell securities. Investors considering any investment should consult with their investment advisor to ensure that it is suitable for the investor’s circumstances and risk tolerance before making any investment decisions. The information contained in this blog was obtained from sources believe to be reliable, however, we cannot represent that it is accurate or complete.
I’m still not sure how this is any easier than Vanguard or Fidelity with automatic investments? I set up a Fidelity account more than a decade ago, and set up an automatic bank transfer to buy a whole market index fund. No transaction fees, no account fees, and the fund itself has a really low expense ratio. The only maintenance it required was going in once a year and increasing how much was automatically invested!
I did this in parallel with a Morgan Stanley actively managed account I’d had for a long time before that. I actually spent way more time dealing with Morgan Stanley because my financial advisor liked to meet for an hour two every quarter – I don’t blame him, because my account made him and the firm a ton of money. But after about three years, it became clear that my simple index fund vastly outperformed the actively managed fund and I fired Morgan Stanley. If I’d done it sooner, I could have made several hundred thousand more!
About the only thing the robo advisor could make easier, is rebalancing – but you probably should only do that once a year, and you really need to take taxes and other income, and current priorities into consideration when you do that, so I’m not sure I’d trust the robo advisor anyway!
But, I’m curious to see the results of your experiment. After all, it was your success at the FIRE experiment that convinced me that I really could do it, myself!
The nervous first-timers is exactly why I often tell folks to use robo-advisors. As much as investing is easy, it’s not actually as easy as we make it out to be. We take a lot of the information that we know for granted. The good thing about a lot of these robo-advisors is that they make investing pretty much as easy as opening up a bank account and putting money into it, and then you get a lot of comfort in knowing that you aren’t screwing up too much.
It’s easy enough to say, put your money into Vanguard, but really, unless you can sit there and walk your friends through it, someone with no knowledge of Vanguard is not going to understand what to do with the money once they put it in. Even saying, put it all into VTSAX is not going to be as simple as we make it out to be. A good example is a friend of mine who opened up a Roth IRA with vanguard on my suggestion, then put the money in and had no idea what he was supposed to do with it. I had to go on the computer and do it for him.
And really, considering the fact that there are now free robo-advisors (M1 Finance and Axos Invest – formerly WiseBanyan, come to mind), it’s even easier now to just direct the nervous first-timer to a free robo to let them get comfortable with investing.
Just curious….how do ‘free robo advisors’ make money to keep the business viable?
While I see the allure to robo advisors, I wouldn’t recommend them. Of course everyone’s situation is different but with all the different balanced index funds out there, just pick one of those if you want a certain stocks/bonds allocation and be done with it. Or if you’re in the states, pick a target date index fund. These type of mixed index funds offer much lower fees than robo advisors and it’s essentially doing the same thing for you. Or better yet, pick a stock index fund and bond index fund and be done with it for an even lower fee. As we know, fees really do matter!
All I can say is PFFFFTTTT to robo advisors. Buy an all in one VBAL, VGRO, XBAL, XGRO in Canada or something similar in the US or another country with an automatic deposit set up. It rebalances itself regularly and no hassles while the MER is around 0.20%. The robo advisor may be trendy but it’s days are probably numbered. Then again, I might be wrong and over-estimate most people’s IQ.
I think the lazy people will be the majority who use them unfortunately.
I like to keep my investing as simple and easy as possible, I ended up creating my own algorithm to act as kind of my own personalized robo advisor. This was all done through Excel.
Keeps my investing automated through my various tax advantaged accounts and non registered 🙂
-DGX Capital
If you have invested assets in taxable accounts read this white paper for the best feature in the robo advisor world:
https://research.wealthfront.com/whitepapers/tax-loss-harvesting/
Yeah, that’s pretty much what I figured.
wanted to put a comment out there on these robo advisors. I am relatively lazy and have tried a number of them. in general i like the idea of not having to worry at all about allocations works for me personally while i’m still in my working phase. Mental stress is still a cost.
One thing i would note, I recently had to give CharlesSchwab the boot, as i realized that they were permanently keeping 6-8% of my portfolio in cash, which is unacceptable given this is a long term investment vehicle and should not be used for short term cash needs. I called them and they said there was nothing they could do about it. Essentially, they make a ton of money on net interest margin and it is in their best interests to keep as much of your money in cash as possible (as well as in their ETFs, although those were still low fee).
I switched to Betterment who had the same fees (25bps over ETF fees), but would fully invest my money (and had a 2% savings account if i had in fact wanted to keep my cash). Also Betterment was much clearer on when they saved me money using their tax-loss harvesting tech. IMO a much better platform, easier to use, better interface, and not trying to steal my money.
tl;dr – the upfront advisor fee is not necessarily the only cost – watch how much of your money they keep in cash… as it does not make ANY SENSE for a robo to keep any cash on the side.
just my 2 cents, hope its helpful.