Episode 12. Tarang Patel, DO — Roboadvisors

This is my first solo episode.

I talk about roboadvisors and the pros and cons of using them. I also review some of the larger and most popular companies providing this service.

What is a robo-advisor? It is a computer algorithm based approach to managing your investments. (Note this generally applies to your stock market accounts) A robo advisor is designed to eliminate the need for an individual to make trading decisions about the stocks or ETFs in an account.  This is not the same as Wall Street computer-based trading which can be millions of trades in a day. Rather, this is designed to simulate a financial advisor in optimizing asset allocation and rebalancing a portfolio when necessary to achieve diversification and some of them are supposed to do tax loss harvesting to reduce the capital gains and possibly reduce some of your income tax as well. These are not generally designed to replace the other aspects of a financial advisor such as goal planning, advice about insurance, tax advice, etc.

So what are the pros and cons of a robo advisor while one benefit is there extremely low cost compared to the average financial advisor most financial advisers range from .75 to 1.25% of your assets under management. Now, there a is a trend of financial advisors going to fixed cost management such as a fixed fee whether you have $100,000 or $2,000,000 under management but those are still the exception rather than the rule.  These advisors are still more expensive than Robo advisors but as noted above, they provide you with a more broad array of advice. If you do end up choosing a human financial advisor make sure you pick a fee-only advisor or a flat cost advisor who holds the CFP designation and is a Fiduciary.

Now getting back to Robo advisors, some of the pros include low cost. The majority range from  free to 0.35% of assets under management, though a few are slightly higher and I’ll talk about those when I discuss the individual ones. The majority of the robo advisors don’t trade individual stocks, rather they use a portfolio of ETFs to give you a wide diversification. In my opinion however, you can generally achieve this diversification with only a few individual ETFs. The second Pro of these Robo advisors is they eliminate this work for you you can just put your money in and basically let the computer do its thing and you don’t have to worry about anything else other than when you end up needing the money.  In my opinion however this is probably not the best way to approach any advisor whether it’s a robo advisor or human advisor after all this is your money you’re putting in if you just put it in and basically ignore what’s happening you are at risk for any number of issues. Always pay attention. It doesn’t mean you have to make the individual trades or decisions but just know what’s going on and that could be as simple as looking at your statements every quarter so that you’re just aware of what’s happening. You may not have any issues and that’s the ideal scenario .

The next benefit of Robo advisors and probably the one that is talked about the most is the tax-loss harvesting. Some of these advisors claim that by optimizing tax-loss harvesting you will improve your returns. If done properly it should override the cost of the majority of these Robo advisors by a significant amount. What is tax-loss harvesting? Tax loss harvesting is where the government allows you to reduce your capital gains and your income tax by subtracting any losses you’ve had from your investments from any games you’ve add so for example let’s say you own an ETF which covered the S&P 500 and that ETF you’ve had it for 5 years and the S&P has done relatively well over the last five years has gained $5,000 so you had a $10,000 investment and it’s $15,000 now I’m not sure if those are the exact numbers but let’s just use that so if you had another ETF let’s say was an international ETF and for whatever reason that ETF did poorly and you lost $4,000 Your gain of $5,000 is subject to taxes if you only sold the position where you had a game but you also have this International ETF where you lost $4,000 so if you take the two together and your Net gain is only $1,000 and you only owe taxes on that thousand dollars. now let’s say instead of a gain of $5,000 you only had a gain of $2,000 and you had the same $4,000 loss on the international ETF well in that case your net loss is $2,000 and that can be used against your ordinary income which for most positions is taxed at a higher rate than long-term capital gains so that tax loss of $2,000 is actually worth more to you because it can reduce your income of let’s say $250,000 to now $248,000 and that’s what you can text on which can be a savings of a few hundred dollars on your taxes.  So why does a robo advisor do this better than humans and what ends up happening is that most years  unless you need to sell the underlying security you don’t want to take anything with a game particularly in a taxable account because you basically reduced your Net game because you have to pay the rest in text so you’re better off holding games for as long as you can but of course within reason because at some point you will have to take the money out when you need it but none like you should be taking every year use them to reduce your regular income as much as possible now as a loss

Okay so that is tax-loss harvesting and if done properly it can help boost your returns. The promise of Robo advisors is that they’ll do this for you so you don’t have to think about it at a fraction of the cost of a human advisor.

So what are some of the cons of picking Robo advisors well one is the cost like I said it’s not free for the most part there are a few that are for me but they tend to have a little bit more limited services. the next is and I don’t know that this is particularly on it’s just that you could probably do this yourself without spending that much time and get almost similar results. Now  in my opinion most of the time you’re probably better off simplifying your accounts as much as possible and doing the stuff that you do need to do on your own just so that you are aware of your finances and no one for lack of a better term screw with you.

Who are some of the companies that have these Robo-advisory services

The most famous ones and probably some of the earliest ones are betterment and wealthfront other companies include wisebanyan and then some of the larger discount brokerages now offer these services such as Vanguard Schwab fidelity. some of the traditional Wall Street firms such as Merrill Lynch and Morgan Stanley also offer these but I don’t have enough information about reviewing them.

So let’s talk about the individual companies now

Betterment

1. 0.25% fees. (0.4-0.5% if you want access to a human CFP, only available on portfolios over $100k Fees not charged for any assets over $2mil
2. Uses low cost Vanguard and iShares ETFs (No trading costs, but the ETFs have their own fees (low cost but are not included in the above management fee)
3. Claim to generate an extra 2.66% in annualized return over 20 years on a $100k portfolio based on
   1. Passive investing
   2. Tax harvesting
   3. Better behavior
4. In my opinion, I would only count the extra (0.4%) for tax loss harvesting as a true gain, because the other 2.2% can be achieved by anyone who uses index funds or ETFs and does a buy and hold philosophy

Wealthfront

1. 0.25% fees
2. Claim up to 2.05% increase in returns due similar factors as Betterment
3. Unique feature called direct indexing (instead of using ETFs, if you have >100k in your account they buy a portfolio of individual securities to improve tax loss harvesting opportunities (Basket of 1000 stocks which always has some losers so you should have more likelihood of being able to take losses against income vs ETF which is the average of all these stocks so if market is up you can’t take a loss even though some stocks are likely down) Link to the methodology on my website. If you do use this feature or even with ETFs you have to make sure that you don’t make any transactions in accounts not managed by the robo-advisor which may conflict with IRS Wash Sale rule A wash sale is the sale at a loss and purchase of the same security or substantially similar security within 30 days of each other. If a wash sale transaction occurs, the IRS may disallow or defer the loss for current tax reporting purposes. More specifically, the wash sale period for any sale at a loss consists of 61 calendar days: the day of the sale, the 30 days before the sale, and the 30 days after the sale. The wash sale rule postpones losses on a sale, if replacement shares are bought around the same time.
4. Features
   1. Passive Plus (Basic robo-advisor service similar to others)
   2. Direct Indexing (Kicks in for free once assets > $100k)
   3. Advanced Indexing (Alternative weighting to traditional market cap ETFs) Kicks in for free once assets > $500k Link to explanation about advanced indexing.
5. Uses Low cost ETFs (Avg fee is 0.12% so net fee is around (0.37%)

Vanguard Personal Advisor Services

1. Hybrid model with Human and robo advisor
2. Need $50k to invest.
3. Fee 0.3% plus ETF costs
4. They give you a dedicated advisor if >$500k managed
5. Mostly vanguard products but can use others (you may incur transaction costs but likely minimal
6. Not quite as much automated tax loss harvesting

Wise Banyan

1. No management fee at all for basic account
2. No trading fees
3. Low cost ETFs (ave .12%)
4. Only for individual taxable accounts or IRAs (No joint accounts with spouse or kids trust accounts)
5. Tax loss Harvesting is extra (0.25% up to $96k. No additional cost after that)

Schwab Intelligent portfolios

1. No management Fee
2. Account Minimum $5000
3. Variety of portfolios (including conservative moderate and aggressive)
4. Pro or con is they maintain a cash position which can be a drag on return (they can also make money by loaning out this cash)
5. Tax loss harvesting available if portfolio > $50k

SoFi Wealth Management

1. 0.25% fee (First 10k free and no management fee if you are existing SoFi loan customer
2. No tax loss harvesting
3. Low account min ($500)

Personal Capital

1. High cost (0.89% up to $1 mil) reduces incrementally downward at higher levels
2. Great App to track investments (free but they will call you occasionally to try to get business)
3. Minimum investment amount $100k

Fidelity Go

1. 0.35% fee
2. ETF only (Fidelity or BlackRock iShares)
3. No tax loss harvesting
4. $5k minimum

DIY (Do it yourself)

1. First don’t bother in a retirement account. (No need to TLH) If you don’t have much interest, use a target date fund.
2. Alternatively use a 2 or 3 fund portfolio of a US Total stock, Total International Stock, and Total Bond fund. If you are far from retirement you can eliminate the Bond Fund. Here is a link to simple portfolios that you can use from bogleheads.org. Most retirement plan providers have some index funds in them and it will save you thousands of dollars over the long run if you take the time to find them when you first start
3. In a taxable account, there are a few simple options. Again you can use a target date fund to keep it really simple, or you can use the multi fund portfolios. In a taxable account, it may make more sense to use a few more funds/ETFs so that you have the ability to TLH.

I personally do the DIY, but I am not sure it is the best over the long term. At the time of this podcast recording, I have no robo advisors, but I do have accounts with some of the companies mentioned. I do not currently receive any advertising from these companies. In my general opinion, the best options seem to be Wise Banyan for those who are just starting out, and Wealthfront for those with more assets to invest. I’m sure the other companies are fine also. Remember I am not a financial advisor, rather a DIY investor. Please do your own due diligence before investing with any of these companies.