I tried a popular robo-advisor this year. While the service has a slick website and some nice features, I always questioned whether it was worth the 0.15% fee. Some have commented that this level of fee falls into the range of "noise". Others, including the service's promotional materials, claim that the advanced features of the service more than make up for the fee. I'm going to make a case that it isn't worth it. To many readers this will be obvious, but it's not obvious to everyone, so I will try to be thorough.
A Tiny FeeI made a spreadsheet to calculate the effect of a 0.15% fee on a $300,000 portfolio over 30 years. I chose $300,000 because a 4% annual withdrawal is $12,000 per year, or $1,000 per month, which is a nice round number. I assumed a 7% growth rate. The 4% is taken out annually, as well as the "tiny" 0.15% fee. But the fee is then invested at 7% in a separate column.
After 30 years of growth and withdrawal, the original $300,000 account stands at $676,854. The annual advisor fee started out at $464 and ended at $1,046, which does indeed seem like a small slice of the portfolio. The total fees paid during that time come to $21,507 -- an unpleasant number. But if they had been invested at the same 7% rate the account was earning, the fees you paid would have been worth $63,172 in the end. That is 9.33% of the total value of the portfolio from "noise".
The sixty-three thousand dollar question is, are you getting your money's worth?
Fancy portofolioObviously, a fancy portofolio of between 6 and 12 funds at very precise allocations can be recreated in a Vanguard account without the 0.15% advisory fee. There are claims that this portfolio is better, well-researched, scientific. I don't know if that's true. Nobody does. Over time everything tends to revert to the mean. There is no guarantee that a fancy robo-portfolio will outperform the Vanguard Total World Stock Index, VTWSX (etf: VT) or a combination of VTSAX (etf: VTI) and VTIAX (etf: VXUS). And there are a thousand intelligent portfolio recommendations out there. The future advantages of the robo-portfolio over a simple portfolio are unknown. But if you think their portfolio is so special, you can recreate it without paying their fees.
RebalancingSupposedly automated rebalancing will get you an extra 0.4% per year. But according to this Vanguard study (
http://www.vanguard.com/pdf/icrpr.pdf), you can get most of the benefit from rebalancing if you do it either annually or quarterly. Even if you have a fancy portfolio with ten funds or ETFs in it, it will take just a few minutes to type their values into a rebalancing spreadsheet every quarter, and a few minutes more to make the necessary trades. Rebalancing does not require a fancy algorithm. It can be done with a simple spreadsheet.
Cash DragA big deal is made out of eliminating cash drag. Since the robo-advisor is so efficient and can assign you fractional ETF shares, there is no cash drag. Cash drag does cost you money. But how much?
If you invest in mutual funds, there is no cash drag.
If you invest in ETFs, cash drag is limited to the price of the lowest-priced ETF in your portfolio, multiplied by each account. As long as you have enough cash to buy a share of the cheapest fund, you can invest. Now the robo-advisor would say that being forced to buy a fund you don't necessarily need more of will throw off your allocation. But unless your account is very small, the portfolio drift this will cause is tiny.
Right now, VWO, a popular component of a robo-portfolio, is trading at $36 and change. The cost of leaving $36 perpetually uninvested over 30 years, at 7%, is $274.04. If you have four accounts (taxable, IRA, Roth IRA, 401k), then it would be $1096.16. Yes, there is a cost to cash drag, but it's a lot less than the advisory fee.
You could invest in mutual funds instead of ETFs and eliminate the problem. Or use ETFs in your taxable account only, for their trading and tax advantages.
Investor BehaviorThis means not trying to time the market, staying the course, not freaking out about a correction, and so on. This is totally under your control. You will have to learn good behavior whether you have a robo-advisor or not, because you can wreck your returns in a robo account just as easily as you can in a Vanguard account. The robo-advisor sends you the occasional educational email and tries to nudge you to not change anything and contribute as much as possible. All fine ideas, which you can do on your own.
Tax Loss HarvestingThe robo advisor tax loss harvesting algorithm is impressive. But it won't work in an IRA. So any gains apply only to your taxable account.
The robo advisor is looking for harvesting opportunities every day, which is something most of us don't have time for. But I wonder if the average investor can tax loss harvest once a year, or once a quarter, and get the majority of the benefit without paying the advisory fee.
If the market keeps rising over time, at some point, tax loss harvesting opportunities will disappear. If you keep contributing to the account you may continue to have tax loss harvests. But once you stop contributing and retire, those opportunities will probably disappear.
Some of us may be more interested in tax gain harvesting. If your long term capital gains rate is 0%, it may be more intersting to lock in some of your gains every year. Only you can do this because only you know what your income and tax situation is, so only you know how much gain to realize.
Automatic tax loss harvesting can hurt some of us. If your income is too low, you won't qualify for the health insurance tax credit and would have to go on Medicaid, which I consider unacceptable.
Tax loss harvesting seems to benefit you only in the early stages of investing, and only if you're already rich or are in a high income tax bracket. The percentage gain they claim is, to me, dubious. It will vary greatly with each individual, and in some cases actually be zero. And if you really care, you can do it yourself once a quarter.
I'm not going to do the analysis required to compare automatic TLH with DIY TLH. There may in fact be some small gains with auto TLH, but my gut feeling is that this robo feature is being oversold. The TLH gains they advertise are hard or impossible to quantify, and vary with each individual. Besides, nobody can predict future stock prices. If you move your entire portfolio into a robo account today, there is no guarantee that you will ever see a tax loss harvest on any of it.
ConclusionRobo advisors are a bad choice for anyone with a brain. And while many have said they're a smart choice for Mr. and Mrs. Average American, I disagree. They can put all their money into a LifeStrategy fund and call it a day. Hell, even a sophisticated investor may choose the one fund approach and save a lot of time and headache.
The reason I wrote all this is that I'm disappointed. I understand the power of technology to make things simple. It's something that I work on every day in my business. The robo-advisors are well designed and they have good features and a lot of potential. But the fact that they charge an asset-based fee is simply insulting. It should cost the same for a computer to manage $1,000,000 as it does to manage $1,000. I would consider paying a fixed fee, like $100 a year, for some of these services. Well, not really, because I prefer to do it myself. But I could see value in paying a reasonable fixed fee for services rendered. But not a percentage of assets under management.
0.15% is not tiny. It has a huge effect on a portfolio over time. Why would you trade 9.33% of your life's savings for a coach who tells you to stay the course?