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Tuesday, April 4, 2017
Active vs. Robo Advisors
Almost everyone at some point has worried about money. Where to get it, what to do with it when you have it, how not to lose all of it. The basics. For most people, they don't know enough about the stock market or economics to feel comfortable investing their money on their own, so they turn to money managers. This is where you can get ripped off by the smaller money institutions wit loaded funds and high expense ratios. With the bigger firms there is more to be offered for much less. Below we'll get into what active investing is and the alternative to it if you like it but can't do it yourself. Then we'll try and scrape the surface on the recent financial innovation in robo advisors.
Enjoy the read.
Active Investing
Active investing is for: People who have a lot of knowledge on the stock market and know what to look for in technical analysis and fundamental as well. People who have the time to check up on their investments very often to rebalance their portfolio and keep it in line with their original risk tolerance. And for people who have the will power, the drive, to sit down and do the research, who have thick skin and know when to admit they are wrong and how to correct it for next time. Basically, for the retail investor active investing comes down to will, skill, and time. Do you want to do it, can you do it, do you have the time to keep up with it. For some people those are all resounding yeses and I salute you. For most of us that is not something we are able to do on our own.
If this is the case and you still want active management, whichever firm that holds your brokerage account most likely has the option of putting the money into an account actively managed by a group within the firm. That may seem confusing, so we can use Fidelity as an example. This was the easiest information to find over Schwab or Merrill Edge. No bias.
Screenshot from Fidelity website
This is just a pricing and service example. If you have money at Fidelity, whether it's in a brokerage account, a traditional or Roth IRA, or in your 401k, you would be eligible for their portfolio advisory service. If it's in a 401k, it would need to be inactive for you to roll it into a managed account. With Fidelity, the minimum amount you need to have to be able to gain access to their portfolio managers is $50,000. Is the amount of money increases, the number of different services available to you increase while the gross fee goes down. These accounts above are all managed by a group of people in Boston.
Obviously there is going to be a relatively high fee for a managed portfolio. Part of it is goes to the salary of paying the money managers, and the rest is for the buying and selling of securities as well as the expense ratios of ETFs and mutual funds.
Robo-Advisors
The wikipedia definition of Robo-advisors is a class of financial adviser that provide financial advice or portfolio management online with minimal human intervention. They provide digital financial advice based on mathematical rules or algorithms.
Fidelity Go is Fidelity's version of a Robo-advisor where the minimum is only $5,000 with a significantly lower advisory fee. You'll see that it's the same situation with most other companies as well. A low minimum investment and a much lower price. A Robo Advisor is essential an automated management service. Some of them offer automatic rebalancing and even tax loss harvesting. Rebalancing is one of the most important aspects of any portfolio management as it allows the person to keep the investment allocation in line with their risk.
Tax loss harvesting is best explained with an example. Person 1 has a portfolio value of $10,000 dollars with a $5,000 dollar initial investment. Person 1 has gains of $6,000 and losses of $1,000 bringing the value to $10,000. The tax loss harvesting is the act of selling the losing position (realizing the loss/crystalizing the loss) to counteract the realized gain of any other previous sale. The value of the portfolio will ultimately stay at $10,000 and the amount of taxes required will be lessened.
After doing research, Betterment and Wealthfront are the two best robo advisors. They each have very low initial investments, $0 and $500, respectively. From there, they offer the most customization in terms of what the investor would want. Some of the research can be found here. If you click this link, make sure you read the notes at the bottom of the chart. More importantly, they offer some of the lowest management fees in the business at between 0.15%-0.35% and 0%-0.25%, again respectively.
Investors who choose Betterment and have a portfolio value under $10,000 would incur and extra $3 dollar charge per month. Unless they deposit $10 every month. Otherwise, the handful of portfolios to choose from consist of mostly Vanguard and iShare ETFs. The services they promote are tax loss harvesting, auto rebalancing, and having a mobile site.
Investors who choose Wealthfront don't have that extra fee, but they don't get any advice regarding their 401k or any other outside accounts. They are the most well funded robo advisor and the most well known. Like Betterment, they offer tax loss harvesting, auto rebalancing, and they have a mobile site.
Conclusion: Robo advisors offer very simple portfolio for people with a modest amount of money for a low price. It isn't a customized plan for you, but they appeal to most people and offer returns nearly matching the indexes that the funds track. The low prices have been a selling point for millenials who are looking for a place to put their money and not worry about it during market ups and downs. The upside to rebalancing and more active management comes during the market corrections and recessions as the downside is typically limited. Overall, I think they are a great product for many people and a great example of innovation from the financial industry. If you have any time you could probably set up similar portfolios for less cost by investing in the Vanguard and iShare ETFs. If not, they a robo advisor is a perfect option for a low cost, more passive approach.
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