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Have you noticed that robo-advisors and automated investing has grown in popularity over the past few years?
Well in today’s post, I’ll explain exactly what robo-advisors are and what they claim they can do for your investment portfolio.
But the real question is:
Does the performance of robo-advisors and other automated investing technologies live up to expectations?
Let’s find out.
In this chapter, I’ll explain exactly what robo-advisors are programmed to do.
First, you’ll learn the basic idea behind robo-advisors.
Then, I’ll help you understand whether a robo-advisor is right for your particular situation.
In the recent years, new technology has emerged that will manage your investment portfolio for you with only a few inputs and 10 minutes of your time.
In fact, Investopedia projects that the assets under management by robo-advisors will grow to $2 trillion by 2020.
How does it all work?
Then, they put all this information into their number crunching algorithms and computer software to come up with an optimal investment portfolio for you automatically.
A well diversified and balanced portfolio.
On an frequent basis, these robo-advisors will even rebalance your portfolio and do a tax-loss harvest daily to save you on some capital gains taxes.
At the end of the year, one tax strategy is to liquidate any losing investment positions to offset any capital gains you may have for the year. The result is a lower tax burden.
Robo-advisors are more affordable than human financial advisors.
Robo-advisor fees typically range between 0.15% - 0.50% of assets per year. That’s $150 - $500 in fees for every $100,000 invested.
That’s a pretty good deal when you compare the fees to a human financial advisors where they typically charge anywhere between 1% - 5% of assets per year.
But is there a cheap alternative?
If you are able to do a little bit of your own investing research, you may be able to find ETFs with fees as low as 0.10% per year.
Specifically, ETFs like SPY and QQQ have very low management fees.
ETFs or Exchange Traded Funds are passive investment funds that invest in a basket of stocks. They typically focus on a subset of stocks to achieve a certain investment goal. Some examples are SPY, QQQ, DIA, and IWM.
So, if you are someone that wants a cheaper option, robo-advisors may not be the best bet.
Robo-advisor services may be perfect for those investors not interested in doing a little bit of research, since they do everything for you.
However, you are paying for that luxury.
If you are someone new to investing, this also may be a good option. Many of the robo-advisor services have no account minimums, so you can deposit as much or as little into your investment account.
Typically with other types of investment accounts or financial advisors, there is a minimum account balance. This can range anywhere between $2,000 and upwards of $100,000.
Another perk of robo-advisors is that they are computers, which means they are emotionless when it comes to making investment decisions.
This may avoid costly mistakes when bring human emotion into the mix. (Buying the high and selling the low based on emotions like greed or nervousness)
In this chapter, I’ll list a couple of the most popular robo-advisors and key features of each.
Then, I’ll let you decide which one is best for you.
Let’s dive in.
Here’s our comparison of the three most popular robo-advisors: Betterment, Wealthfront, and Vanguard.
Betterment has no account minimums, while Wealthfront has a $500 minimum.
On the other end of the spectrum, Vanguard robo-advisor has a $50,000 minimum.
On surface level, Betterment is the best for the lowest account minimum. But this shouldn’t be the dividing factor when it comes to picking the right robo-advisor.
Betterment charges 0.25% for its Digital plan and 0.40% for its Premium plan. However, if you deposit more than $2M into a Betterment account, it will discount the fees by 0.15% for Digital and 0.30% for Premium services.
Wealthfront charges 0.25% across the board.
Vanguard charges 0.30% no matter how much you invest. The higher fees does come with additional services like access to human assistance.
Less than $500
Between $501 and $2M
More than $2M
When it comes to tax-loss strategies, both Betterment and Wealthfront will automatically perform tax-loss sales for you.
Both are very tax efficient since they are using passive index funds, which typically avoid short-term capitals gains altogether.
Vanguard does not offer this service automatically. Instead, the Vanguard fund advisors will decide whether to pursue this tax strategy on a case by case basis.
Betterment and Wealthfront invests your money into over 10 different funds based on how you answer your onboarding questionnaire.
These funds range from US stocks, international stocks, large cap stocks, mid cap stocks, treasury bonds, treasury protected bonds, municipal bonds, and a whole host of others.
However, Wealthfront does have a leg up on Betterment since Wealthfront has a fund for natural resources and a fund for real estate.
This makes Wealthfront more diversified.
Vanguard portfolios typically invest your money in many of its proprietary mutual funds and ETFs. These typically include the Vanguard Total Stock Market Index fund, the Total International Stock Index fund and the Total Bond Market Index fund.
From there, your advisor would handpick the remaining funds to invest in based on your financial goals and risk tolerance.
In this chapter, I’ll show you the most important part of any investment decision.
That is its projected returns.
Let’s dive in.
On the surface these robo-advisors seem very appealing with all the advanced services and automation.
However, as an options trading education website that preaches active trading to achieve higher returns than the benchmark, the returns of robo-advisors do not seem appealing to us.
The reality is that these robo-advisors don’t live up to expectations.
Let me explain.
When you look at both Betterment and Wealthfront returns, neither return higher than the benchmark S&P 500.
The S&P 500 is a market capitalization weighted index that tracks the value of the 500 largest companies in the United States.
Since 2004, a Betterment 80% stock portfolio return an average of 7.4% annual return. During the same time period, the S&P 500 returned 8.6% annually.
Even a Betterment 100% stock portfolio underperformed the benchmark by 0.4%.
Wealthfront tells a similar story.
With a risk score of 8, Wealthfront portfolios returned 7.14% annually since 2011. The comparative benchmark (S&P 500) returned 8.25% annually during the same time period.
You are paying these advisors higher fees, but getting lower returns compared to just investing in the S&P 500 as a whole.
When it’s all said and done, you really need to manage your own investments if you want better returns.
This is the exact reasons why at Option Posts, we prefer to manage our own portfolios through trading options contracts.
In our opinion, options trading is the only way to outperform the benchmark.
Now I’d like to hear from you:
What’s your take on robo-advisors?
Or would you take the DIY approach?
Leave a comment below and let me know.
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