September 20, 2014

Robo-Advisors: Wealthfront, Betterment, Personal Capital, FutureAdvisor, SigFig, and LearnVest

Through 2022, the U.S. Bureau of Labor Statistics projects the change in employment for personal financial advisors will grow 27%. The average for all occupations is 11%. Why does the BLS believe the demand for professional financial advice will grow so rapidly? Namely, the population will continue to age and life expectancy is increasing, leading to increasing need for financial planning to navigate retirement. But what about younger generations who don't need the personal touch of working with in-person with an advisor, but aren't necessarily comfortable with a complete DIY approach?

Are robo-advisors like Wealthfront and Betterment the future of financial planning?Enter the "robo-advisors". This relatively recent advent falls somewhere in between a completely passive approach and active management. To give you an example, Wealthfront, one of the leaders in this space, recently crossed $1.4 billion in AUM. Even the 49ers offer the service to their employees! What is the company offering? Well, based on your individual risk tolerance, the company recommends an asset allocation for you based on Modern Portfolio Theory, then customizes a mix of low-cost ETFs (mostly from Vanguard). From an equities perspective, the firm uses VTI, VEA, and VWO to cover U.S., foreign, and emerging markets respectively. You'll find recommended asset allocations from virtually any self-serve broker, however. What really makes Wealthfront different is the services they offer beyond that. Directly on the company's homepage you'll find a performance chart that illustrates an annual excess return of 4.6% due to a combination of factors. First, 2.1% of that is due to using low-cost ETFs rather than mutual funds. Next, their automated tax-loss harvesting could potentially result in 1% of additional yearly gains. Another 0.5% is attributable to optimal asset allocation, 0.4% to automatic rebalancing, and 0.6% to tax-aware allocation. For all of this intelligence in your portfolio, Wealthfront charges nothing on the first $10,000 invested, and a mere 0.25% on anything above that. This is impressive considering that many financial advisors will charge 1-2% annually in comparison. The disclaimer on the company's site gives a bit of insight into how they came up with these excess return figures. It's worth debating whether or not the 2.1% attributed to low-cost ETFs instead of mutual funds is relevant. I don't see it as an either/or type of decision. In other words, it seems to be quite an assumption that if you invest elsewhere you'll have your money in a bunch of funds with expense ratios around 2%.
The low-cost funds they invest in are available to everyone, with just about any broker.

Next, the 0.5% due to optimal asset allocation is based on a simulation vs. what an online asset allocation tool at Fidelity recommends. This may have been the case recently, but there's no guarantee that any particular allocation will outperform going forward. As different asset classes experience stretches of superior returns, different allocations can come in and out of favor.

As for rebalancing, it's tough to say what frequency works best over time, but it's not unreasonable for individual investors to do it themselves once every year or two. In fact, you could do so pretty easily by getting broad global exposure to equities in just one ETF, then pairing it with a broad bond ETF like iShares' AGG or Vanguard's BND. And doing so can be pretty cheap if you're with a broker that has a good selection of commission-free ETFs. Tax-aware allocation is pretty similar, in that individual investors can actively seek out investments that will be a bit more tax efficient.

Ditto for tax-loss harvesting. For these purposes, Wealthfront may swap out their core Vanguard ETFs with something similar (often from Schwab) to kick the tax can down the road. Now some have questioned the merits of how the benefits of tax-loss harvesting were calculated (here too), but ultimately this is a strategy that anyone can employ. Noticing a theme? A lot of what the company is something you can do yourself, but a bigger question might be, do you want to do it all yourself? And keep in-mind, if the majority of your funds are in tax-deferred retirement accounts like a 401(k) or IRA, this isn't really a concern.

That said, there's a lot of merit to what Wealthfront is doing. The 0.25% annual fee is relatively reasonable. Higher expenses can of course lead to drastically lower returns over time, but a quarter of a percent is somewhat modest and could very well be worth the peace-of-mind for some investors. A lot of folks may not want the headache of micromanaging their finances year-after-year or the anxiety that can come with it. And if you don't have the patience to stick with an investment plan you set for yourself, you could easily cost yourself far more than 0.25% annually trading in and out of varying investments.

Wealthfront gets a lot of attention, but there are others offering similar services. Betterment is one of its better-known competitors, and you'll notice some overlap in its portfolio offerings. Again, Vanguard and iShares ETFs make up most of the core holdings. Outside of the Vanguard Total Stock Market ETF (VTI), there's one key difference. Betterment favors the value variants of Vanguard's large, mid, and small cap funds (VTV, VOE, and VBR). At the large and mid cap end of the market cap spectrum, I've had trouble finding any evidence of a persistent value premium, although at the small cap end of the spectrum value has pretty convincingly outperformed growth over time. Betterment's pricing structure is a bit different. If you have less than $10,000 to invest, you can do so with a $100/month auto-deposit and a 0.35% annual fee. With over $10,000 the fee drops to 0.25% (and the tax-loss harvesting feature kicks it at $50k). What's most impressive is that investors with a $100,000 minimum balance pay only 0.15% of their average annual balance. A large portion of Betterment's investments charge minimal expense ratios, under 0.15% or even 0.10%. Including Betterment's services, an investor could very well pay less than 0.3% in fees each year.

While Wealthfront and Betterment manage the most assets in this space, there are a handful of notable competitors gaining traction as well. Personal Capital offers an integrated dashboard to track your finances across accounts, somewhat similar to Mint. The company's wealth management services appear to be a bit more hands-on and personalized, as opposed to completely automated asset allocation. However, the fees are accordingly higher than those charged by Wealthfront and Betterment. 0.89% for the first $1 million, to be exact, then gradually dropping to 0.49% if you happen to have $10 million to invest. It appears they're targeting higher net-worth individuals and compete more directly with traditional financial advisors.

One look at the FutureAdvisor website and you might swear you were reading the description for Wealthfront or Betterment after perusing their services. They hit all the check boxes with personalized asset allocation, tax aware investing, tax loss harvesting, and rebalancing. With a 0.5% annual management fee, however, investors need to carefully examine whether there's anything unique from FutureAdvisor that justifies the higher costs in comparision to its cheaper competitors.

Then of course there's SigFig. Many people may recognize their signature logo, the pig wearing a monocle. In a case of serious deja vu, we once again see a chart of excess returns based on their fund selection, allocation, rebalancing, and tax-aware asset allocation. Commission-free trading is built into this as well, but it's not hard to trade commission-free with many brokers. Some of their assumptions listed in the SigFig disclosures are similar to those of Wealthfront. Namely, the 2.1% advantage of investing in index ETFs instead of mutual funds. Like Personal Capital or Mint, SigFig will consolidate information across your investments at other brokers into one unified dashboard. The company also provides asset management services for $10/month; quite a different pricing model than what we've looked at so far (no trading fees or commissions). For investors with a lot to invest, this is pretty attractive, all else being equal.

Lastly, LearnVest offers a slick dashboard to track your money across accounts and offers personalized advice for a fee. What's interesting is the focus some of their plans have on personal money management. As opposed to some of the other options out there that center entirely around investing, LearnVest can tailor advice around spending habits or 5-year plans (to get out of debt, take a vacation, etc.). The company's spectrum of financial advice programs have one time set-up fees ranging from $89 to $399, then charge you $19/month.

There are some correlating the rise of various innovations in investing with impending bubbles, so take that for what it's worth. It is worth noting, however, that robo-advisors altogether have less AUM than many medium-sized ETFs, so they're still just a drop-in-the-bucket for now (for perspective, there's about $181B invested in SPY compared to maybe a few billion managed by these robo-advisors). This is just my opinion, but as always, do your own research and draw your own conclusions.


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