Are Robo-Advisors Worth It?

Robo-advisors are a recent innovation in the fintech industry. The two best known companies are Wealthfront and Betterment, although Schwab, Vanguard, and others are moving into this business.

What is a robo-advisor?

It’s an automated investment advisor. Instead of working with a human financial advisor and discussing your age, income, expenses, goals, savings, and risk tolerance, you answer a questionnaire. The robo-advisor uses an algorithm to determine the best asset allocation and investment strategy for you. Typically, the robo-advisor invests in a mix of low-cost ETFs, rather than mutual funds or individual stocks and bonds.

The robo-advisor monitors your portfolio over time and automates any re-balancing of your different investment assets. For taxable accounts, it also pays attention to minimizing your taxes through strategies such as tax-loss harvesting. There’s no artificial intelligence at work, just straightforward and sensible investment strategy.

How much does a robo-advisor cost?

Betterment and Wealthfront charge a fee of 0.25% of the assets under management. In addition, the ETFs in which they invest carry their own expenses but these are typically low — let’s say the ETFs average 0.05%. So, the all-in cost of using one of these services is ~0.30%.

Schwab does not charge a fee. Instead, their robo-advisor invests in Schwab’s in-house ETFs and these ETFs typically have higher fees than other ones — closer to 0.25% instead of 0.05%. They also pay less than a market rate on any cash that is held in your portfolio and pocket that difference. In the end, Schwab’s total fees are comparable to Betterment and Wealthfront but are better hidden.

How does it compare to a human advisor?

These fees are significantly less than a human financial advisor who typically charges a fee of 1+%, along with additional fees that may add another 0.5% for the more expensive mutual funds in which they typically invest. For the humans, let’s call it an all-in cost of 1.5%.

The robots are a good deal compared to a human but you lose the opportunity for personalized service and a human touch, especially when the stock market is crashing and you need someone to tell you to sit tight and do nothing.

How does it compare to a target date fund?

Clients know that I’m an advocate of low-cost target date funds for retirement savings. They perform the same asset allocation re-balancing but are less expensive than a robo-advisor. As a comparison, the Vanguard Target Retirement funds charge an expense fee of 0.14%. I would expect the performance of a robo-advisor to be roughly similar to Vanguard’s target date fund.

Should you use a robo-advisor?

These robo-advisors are certainly new, shiny, and high tech but I don’t see their value for retirement savings. I think you’re better off in a low-cost target date fund where you can invest your IRA and “set it and forget it.”

For non-retirement savings, the answer is not as clear as circumstances and investing goals can vary widely. A single low-cost index fund may not be able to capture your goals as well as a robo-advisor might. And, the robot’s tax optimization strategies are likely better than what you would do on your own. In that case, it may be worth paying a bit extra.

On the other hand, if your savings goals are short-term oriented — e.g., an upcoming down payment, car, wedding, etc. — then it seems unnecessary to pay fees of 0.25% when a mix of a low cost stock index fund and a high yield bank savings account might be better and cheaper. Similarly, if you’re saving for the long-term and want to invest 100% in a diversified stock fund, the robo-advisor offers no real advantage either.

Overall, the robots are a useful and lower cost innovation compared to the humans, but they’re a bit more costly than the do-it-yourself alternative.