I’m a fan of the so-called “ robo-advisers.” These are online wealth management services that provide automated software-based portfolio management advice without the use of human advisers. Two of the larger robo-advisers are Betterment and Wealthfront. In addition, Schwab recently launched its version, branded Intelligent Portfolios, and Vanguard has a product called Personal Advisor Services.
Here are three reasons I’m a fan of these adviser services:
Fees matter. And because they do, I encourage people to get real when it comes to investing. By that, I mean thinking realistically about what future returns will be after inflation. A portfolio composed of half stocks and half bonds, for instance, might earn 1.5 to 2 percentage points a year above inflation. So paying an adviser 1 percent to pick funds that have another 0.5 percent to 1 percent in fees is giving up all of the expected real return.
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Robo-advisers generally get it right by charging dirt-low fees and using index funds with very low fees. Wealthfront typically charges 0.25 percent annually, while Betterment generally charges 0.25 percent, which declines to 0.15 percent above $100,000. Though Schwab has no charge, it uses more expensive funds and keeps larger amounts in cash, which earns virtually nothing. Vanguard charges 0.30 percent but gives clients consultations with advisers.
One key reason to use an adviser is for discipline to avoid the all-too-human fear and greed cycle of buying late in a bull market only to panic and sell after a plunge. Unfortunately, traditional advisers are also human, and research shows that advisers timed the market very poorly too, having their clients 74 percent in stocks on the pre-crash 2007 market high and only 49 percent in stocks on the 2009 market bottom.
Robo-advisers’ software algorithms are not human and will automatically rebalance your portfolio when it strays from the target allocations. This means the adviser will sell bonds and buy stocks, or vice versa, to get back to the target allocation. I’m a big believer in rebalancing because it both controls risk and generally goes against the herd.
Greater tax efficiency
Taxes are costs too, and most robo-advisers get that right as well. They use the tax-efficient stock index funds in the taxable accounts, and for your tax-deferred accounts they use funds that are taxed at the highest rates, such as bond funds and REITs. All of this is key to keeping more of your gains.
Next, most robo-advisers do what’s known as tax-loss harvesting. This is simply selling an investment that has gone down in price, in order to take advantage of the tax-deductible capital loss. The adviser then buys a similar fund to avoid being out of the market during the 30-day period in which the IRS would disallow the loss if the exact same security were repurchased.
What to watch for
Most robo-advisers have a set selection of investment funds they use. So moving your money to a robo-adviser would likely require selling current investments, which could trigger tax consequences if there are gains. Of course, this would not be a concern if the money is in a tax-deferred account, such as an IRA.
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Also, beware of any risk profile survey you take that sets your overall allocations. I generally see that investors think they are more risk-tolerant during a long bull market (now) than after a market plunge. While the software should rebalance after a plunge, it doesn’t mean that you can’t panic and yank your money or switch to a more conservative portfolio at just the wrong time.
I love robo-advisers because they are typically cheaper and better than human advisers. Also, they free up financial planners to do what they do best, such as retirement and tax planning, risk management and coordinating estate planning.
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