Are you better off letting a computer invest your money rather than hiring a human financial adviser or doing it on your own? It sounds like science fiction, but “robo advisers,” as they are known, use sophisticated software programs to generate a customized portfolio for you, then manage it, helping with tasks such as automatically rebalancing your portfolio to improve your chances of success.
Although the robo adviser trend is just a few years old, more than two dozen companies ranging from startups to giants such as Charles Schwab and Vanguard expect to use robo advisers to serve hundreds of thousands of investors and manage a total of $60 billion in assets by the end of 2015.
Fees for robo advisers are much lower than fees for human advisers, and robo advisers offer greater objectivity and convenience. But recently, the US Securities and Exchange Commission (SEC) issued a warning that there are risks and limitations in using these automated, online services.
To help you figure out whether “hiring” a robo adviser is right for you, Bottom Line/Personal spoke with investment expert Pam Krueger about the pluses and minuses and which robo advisers might work best for different types of investors…
How They Work
Before you sign up for a robo adviser service, you fill out a questionnaire about your investment time horizon, goals, tolerance for risk, etc. Within a few minutes, you receive a suggested portfolio typically made up of low-cost exchange-traded funds (ETFs) that are passively managed, tracking various indexes. Depending on which robo adviser you choose and your investment criteria, the portfolio typically can hold ETFs tracking eight to 20 asset classes, including various types of stocks, bonds, real estate investment trusts (REITs) and commodities. The ETFs are issued by well-known providers such as BlackRock (the iShares brand of ETF), State Street (SPDR), Schwab and Vanguard.
If you decide to invest in the suggested portfolio, you open an account and transfer money in. Some robo advisers allow you to tweak the portfolio by subtracting or substituting a limited number of ETFs.
The robo adviser oversees the account, typically making changes to rebalance back to your original allocations on a regular basis. If you undergo life changes that alter your risk tolerance, need for cash flow and/or investment horizons—such as marriage, divorce or major illness—the robo adviser can adjust your portfolio.
Some firms offer additional no-fee services, such as “smart” dividend reinvesting (new dividend payouts in certain ETFs are invested in other ETFs whose balances fall short of the portfolio’s desired allocations).
Some robo advisers offer automatic tax-loss harvesting—selling shares in ETFs that have experienced a loss and replacing them with similar ones. (By realizing, or harvesting, the loss, investors offset capital gains and reduce income taxes.) And some offer limited support from human advisers.
The Pluses and Minuses
Annual management fees for robo advisers range from no fee at Schwab and 0.25% of your average asset balance at Wealthfront…to 0.3% at Vanguard and 0.5% at FutureAdvisor, compared with an industry-wide average of 1% for human advisers. (No fee versus a 1% fee is a savings of $1,000 on a $100,000 investment.) You usually are not charged trading commissions for buying or selling shares of ETFs.
One of the biggest benefits of robo advisers is that they can protect you from your own worst impulses, helping you avoid common mistakes such as not diversifying enough…failing to occasionally rebalance back to your long-term intended asset allocations…panicking and selling when the stock market gets rocky…or getting too giddy and overbuying certain investments when they are soaring.
Robo advisers can serve as a supplement to fixed sources of income, such as a pension or an annuity.
If you occasionally need more complex advice—say, you just received a windfall from selling your small business or you want to leave a sizable inheritance to your family—it may be wise to schedule sessions with a fee-only financial adviser or an estate planner.
Be aware that robo advisers have limitations and drawbacks significant enough that they triggered the recent SEC warning.
What you should be aware of…
These services have very short track records. Each robo adviser uses its own proprietary software, which means that your portfolio would vary depending on which robo adviser you use. It’s too soon to know which ones will produce the best long-term results, especially since none have faced a bear market yet. (For some of the differences, see below.)
Most robo advisers don’t manage 401(k) or 403(b) retirement accounts, only taxable accounts and IRAs. Also, you generally can’t transfer investments that you already hold, such as stocks, bonds or mutual funds, into a robo account, although there are some exceptions. That means you would either have to liquidate existing investments or oversee them yourself.
Furthermore, most robo advisers don’t take into account your existing holdings when they choose portfolio allocations for you. This can be a big negative if you have existing holdings that you do not want the robo adviser to manage.
Comparing Robo Advisers
Below are five of the largest, most reputable automated investment services…
- Betterment (Betterment.com) Assets managed: $1.7 billion. Annual fee: Under $10,000, 0.35% of the average balance…$10,000 to $100,000, 0.25%…$100,000 and above, 0.15%. Minimum investment: Below $10,000, you must auto-deposit $100 or more a month or pay an additional fee of $3 per month. What stands out: It offers “smart” dividend reinvesting. (See “How They Work” above.) Drawbacks: There are no REIT or commodity ETFs in its allocations on the theory that its “total-market” ETFs provide exposure to these asset classes.
- FutureAdvisor (FutureAdvisor.com) Assets managed: $520 million. Annual fee: 0.5%. Minimum investment: $3,000. What stands out: It will analyze and include your existing holdings in the portfolio it creates and manages. It charges no fee to manage investments in college-savings plans, such as 529s. Drawbacks: You must open an account with either Fidelity Investments or TD Ameritrade to hold your investments, although FutureAdvisor will manage the portfolio there.
- Schwab Intelligent Portfolios (Intelligent.Schwab.com) Assets managed: $1.5 billion. Annual fee: No robo adviser fee. Minimum investment: $5,000. What stands out: It uses a broader portfolio than most other robo advisers do, with up to 20 asset classes including mortgage-backed securities and gold. Drawbacks: The service has a cash-heavy approach, sometimes keeping 10% or more of a portfolio in a savings account at a Schwab-affiliated bank where it earns very little.
- Vanguard Personal Advisor Services (Investor.Vanguard.com) Assets managed: $17 billion, including $10 billion that Vanguard moved over when phasing out a previous financial-planning service. Annual fee: 0.3%. Minimum investment: $50,000. What stands out: You can discuss your computerized asset-allocation plan by phone as often as you need with someone from Vanguard’s pool of human advisers. Drawbacks: Minimum investment is high…investment options are limited to Vanguard funds and ETFs, which may not be a negative, since they often have the lowest expense ratios.
- Wealthfront (Wealthfront.com) Assets managed: $2 billion. Annual fee: 0% on the first $10,000…0.25% on the rest. Minimum investment: $5,000. What stands out: It offers smart dividend reinvesting. Drawbacks: Unlike the other robo advisers described here, Wealthfront does not allow investors to remove or substitute ETFs in a portfolio.