[Editor's Note: I received this as a guest post a while back, but thought it would be better done as a Pro/Con article. Not necessarily because I thought Tim was wrong, but because I thought more details would make for a better post and you guys all like Pro/Con posts better than regular guest posts anyway, even though they're usually quite a bit longer. In some ways, this will read like a Con/Con, but I'll do my best with the Pro side! Tim Baker, CFP® is the Founder of Wealthshape LLC, a financial advisory firm. Tim is a paid advertiser on this site, but neither he nor I received any money for this post. I also have an affiliate agreement with several roboadvisors, but I'll be honest, I make almost nothing from those agreements.]
Tim Baker, CFP
CON: Are Robo Advisors Really Acting in Your Best Interest? – Tim Baker, CFP®,
The Robo Advisor movement with its simplicity, hi-tech efficiency, and low cost has gained the attention of the general investing public. Once thought of as a fad by traditional financial advisors, “Robo’s” have entered the mainstream and appear to be in it for the long run. It’s time investors start asking some important questions about what this means for their money.
What are Robo Advisors?
Most Robo Advisors like Betterment, Schwab Intelligent Portfolios, Wealthfront, FutureAdvisor, etc., operate similarly, walking you through a brief risk tolerance questionnaire that assigns you to a pre built model portfolio based on your answers. Given the fact that they all use passive, market tracking, index based ETF’s (Exchange Traded Funds) to build their portfolios; you’re likely to find the investment experience fairly similar across the board. This makes the differences between them harder to see for anyone trying to choose between providers.
Is Advice in the Absence of a Human Advisor Advice At All?
While there are great things coming out of this movement, investors need to recognize its limitations. Can something designed to offer turnkey automation always act in the specific best interests of each individual investor? To contrast with a similar movement in the law industry, even legal document platforms such as LegalZoom recognize their limitations; fully disclosing “they are not a law firm or a substitute for an attorney or law firm.”
To discount the importance of human intervention is to suggest that an algorithm can provide all the necessary guidance to being a successful investor. Research has shown that one of the largest inhibitors to investor success is controlling their own emotions. Dalbar Inc. a Boston based research firm demonstrates the gap in performance based on the 20 year return of 9.22% for the S&P 500 compared to the average equity investor return of 5.02% through 2014. There are many factors that contribute to this performance gap, but behavior can’t be discounted.
Most of these providers began gaining serious momentum post the 2008/2009 financial crisis. Betterment and Wealthfront were both founded 2008, Future Advisor in 2010 and Schwab Intelligent Portfolios in 2015. The over 6 year bull market to follow didn’t offer much of an emotional test to the discipline required of buy and hold investors. When markets go south, even subtle changes such as adjusting a portfolio to be more conservative until volatility passes, can have a significant impact on long-term performance. What safety net exists to ensure decisions are being made based on long-term goals and not emotion? At the very least, the absence of quality human interaction, adds some hurdles to the management of investor behavior.
Are Robo Advisors Fiduciaries?
An advisor acting as a fiduciary is required to place the clients best interests above their own. This one’s tough to answer because it's hard to argue that an all ETF portfolio is the most appropriate vehicle for every investor. Therefore, is the Robo Advisor actually doing what’s in the best interest of each individual client? Even though they may suggest the reasoning for using ETF’s is due to the passive, low cost, research driven investment ideology, you could easily argue that Robo Advisors use them largely because they’re easy and inexpensive to trade.
Furthermore, how are the ETF's objectively selected? For instance: are Schwab Intelligent Portfolios being completely objective when using underlying Schwab ETF’s in their portfolios? The same can be said of FutureAdvisor, a company owned by Blackrock that incorporates iShares ETF's. This isn’t a shot at the merits of ETF’s as either a good or bad investment vehicle. It’s a discussion focused on whether or not an all ETF asset allocation is most appropriate for every investor.
Then there’s the largest Robo/Hybrid Robo or whatever you wish to call Vanguard’s Personal Advisor Services offering. While difficult to argue with the low cost nature of their funds, it’s impossible to deny the lack of objectivity. This isn’t a shot at the merits of Vanguard. It’s purely an observation. When choosing Vanguard’s offering, you shouldn’t expect them to be looking outside Vanguard for something better to add to your portfolio.
Are ETF’s always the best solution?
Many Robo’s follow a factor-based approach to asset allocation. Using only ETF’s can present challenges in this area. Factor based strategies seek to target specific elements such as size, value, momentum or profitability that offer better explanations as to how returns have historically been generated. When building a portfolio it’s important to take into consideration how factors interact with one another. Because ETF’s are pure index tracking products, some control over the factor filtering process is lost. As a result, it becomes more difficult to establish multi factor exposures with the same accuracy as a non-index tracking mutual fund. If factor investing or smart beta (essentially the same thing) is what you’re looking for, ETF’s may not be the most optimal solution.
Technology has always been about becoming more efficient and improving the quality of life. However, it’s important to remember that it has its limitations. The tough questions I’ve asked should be asked by anyone intending to hire a financial advisor, Robo or not. Eventually, if enough get answered, investors will be in a far better position to compare the benefits and drawbacks of each option.
PRO: Roboadvisors Might Not Be Perfect, But They Have Significant Advantages Over the Alternatives
All right, I'm supposed to be doing the Pro side, but I'm going to start with a few Cons. They're totally different from Tim's Cons, however, and I think they explain far better why I make so little from the affiliate agreements I have with Betterment, Wealthfront, Motif, Future Advisor, and Personal Capital.
Big Con # 1 These guys don't manage all your accounts
Most Roboadvisors will only do your IRAs and your taxable account. They won't manage your 401(k), defined benefit plan, 403(b), 457, individual 401(k), or HSA. So that means someone has to do that in addition. If that someone is you, why not just do the IRA and taxable too? If that someone is a traditional advisor, why not have them do the IRA and taxable too so they can coordinate everything together as one account? Roboadvisors are recognizing this and some are offering a 401(k). But what they're NOT doing, is offering to manage the 401(k) you already have, which would be much more useful.
Big Con # 2 It is a very small step from using a roboadvisor to just doing it yourself.
Investment management can be ridiculously simple. In fact, it can be so simple that even a computer program can do it very well. But if it is really that easy, why even pay 15-30 basis points for the service?
If those two cons aren't a big deal to you, then I think you ought to take a very serious look at a Roboadvisor, despite what Tim says. So let's get to the Pros.
Pro # 1 All Roboadvisors use a reasonable portfolio
The most important thing with investing is that you pick something reasonable. Investors who do poorly generally do poorly for one or more of three reasons- they didn't save enough, the portfolio isn't reasonable, and they couldn't stick with the portfolio due to behavioral issues. Using a roboadvisor removes the second of those issues. That's worth something. If you don't know what a reasonable portfolio looks like, a roboadvisor will make sure you have one.
Pro # 2 Roboadvisors will take you with nothing
Many financial advisors aren't interested in you until you have $500K-$1 Million. But a roboadvisor will often take you with just a few hundred bucks. The beginning is when advice and service are most valuable, to get you started on the right road, but you are most valuable to your advisor in the end. This conflict explains much of the appeal of roboadvisors- there is no competition from traditional advisors for their service because they're serving totally different markets.
Pro # 3 Roboadvisors are super cheap
Some roboadvisors, such as Betterment, will charge you as little as 15 basis points for investment management. Meanwhile, a traditional advisor might be charging you ten times that much. So what if all the stuff Tim accuses them of is true. Those all seem to be much smaller sins than charging you ten times as much. Financial advice is really expensive stuff, and roboadvisors are offering it dirt cheap by comparison. Is the service from a human advisor better? Probably. Is it ten times better? I think that's a hard argument to make. Tim's fees are low, starting at 0.85% of AUM and dropping to as low as 0.55% after $3 Million, but that's still 3-6 times what a roboadvisor is charging.
Pro # 4 Roboadvisors are probably better at tax loss harvesting than you are
Betterment (and some others) have started offering tax loss harvesting in their taxable accounts, and by all reports it is working very well. It seems to work even better than having a human do it. Some people are even opening a Betterment account because they feel they're getting more than 15 basis points out of the tax loss harvesting service alone.
Pro # 5 You can do less vetting of a roboadvisor
The roboadvisors are all becoming big household names- Schwab, Vanguard, Betterment etc. It's easy to see they're not commissioned salesmen and have only relatively minor conflicts of interest. (It's not like Vanguard and Schwab ETFs are bad funds to invest in.) None of them are going to pull a Bernie Madoff on you. They all have hundreds of reviews online you can read. They're all going to be around longer than any human advisor.
Pro # 6 The Backdoor Roth Button
Betterment has a feature where they show a button that says “Backdoor Roth.” Seriously. All you do is hit the button and your Backdoor Roth IRA gets done. I spend hours explaining to people how to do a backdoor Roth. Betterment has a button. That's pretty cool.
Now, a few specific criticisms of Tim's piece.
First, is advice from a roboadvisor really advice? Of course it is. Are you probably getting less advice and service than from a human? Probably, but it's not like there is no advice or service there. Give me a break.
Second, Tim is bringing up the Dalbar study like pretty much every other advisor out there saying, “See, you guys are idiots and if you try to do this yourself you're going to shoot yourself in the foot.” While I think there is some truth to that for many investors (please read a behavioral finance book and a financial history book if you have not done so), the Dalbar study has some pretty serious limitations that rarely get explained. They basically compare the time weighted return to the dollar weighted return and conclude that because the dollar weighted return is lower, then investors are killing themselves through bad behavior. But there are other reasons the dollar weighted return is lower, such as the fact that individual investors make periodic investments. This makes the dollar weighted return lower than the time weighted return when the market is rising (like it usually does) and vice versa. When you eliminate that effect, and the effect of a good advisor's fees, and the effect of the risk of potentially mistaking a bad advisor for a good one, the behavior gap is far smaller than they'd have you believe.
Third, Tim argues that robos aren't fiduciaries. I have to laugh a little bit. Would a fiduciary charge you $10-30K a year to do something that can mostly be done by a computer program? Does that sound like someone looking out for your best interest? Yet that is what many fee-only advisors do.
Fourth, Tim argues that Vanguard, Future Advisor, and Schwab use their own ETFs. What he doesn't mention, however, is that those ETFs are pretty much all fine. Not a bad one in the bunch.
Fifth, Tim argues against using ETFs at all for all investors. Yes, there are some advantages of mutual funds over ETFs. I use both myself for various applications. But the fact is any advantage of a mutual fund over an ETF pales in comparison to the price difference between a roboadvisor and a traditional one.
CON Rebuttal
Regarding Roboadvisor Portfolios Being Reasonable
I agree with WCI that roboadvisors may not eliminate behavioral issues. WCI says all roboadvisors use a reasonable portfolio. However, this is an untested aspect. Provided the upfront risk tolerance questions are answered with perfect honesty and conceptual understanding, then yes, they will provide a “historically reasonable” portfolio. I say historically because when addressing risk, it's easy to over simplify. During the 2008/2009 downturn most portfolios fell out of the historical norms in terms of volatility measurements such as standard deviation. Despite being in a reasonable allocation, many investors strayed from their moderate portfolios into more conservative portfolios. Asset allocation changes should be made based on financial planning related items. I agree. Being a successful investor involves all three topics (savings rate, asset allocation, and behavior) so I believe any service offering professional guidance should look at all three.
Regarding Advisory Expenses
WCI says Roboadvisors are “super-cheap.” I agree that if you were to look at the advisory community as a whole you would find that most are charging excessive fees for their services. It's one of the biggest reasons that Robo's have gained traction. However, there are some of us that are not even close to ten times the price. Just as Robo's were the response to 1%+ fees associated with traditional advisors, I built WealthShape as a response to Robo's because I believe that professional guidance and investment management go hand in hand providing they're reasonably priced. WCI does a good job of screening those advisors listed on the site.
[Ed. Note: Tim's fees on a $100K portfolio are 0.85%. Betterment's are 0.15%. That is 5.7X higher. I'll let readers decide if they would describe 5.7X as “not even close” to 10X. Obviously some robo advisors charge more and Tim's fees decrease when you hit seven figures. I agree with him that when the ranges start overlapping you might as well have a human. The main benefit of a roboadvisor is the much lower cost.]
Regarding Fiduciary Duty
WCI gives fair criticism here. I should clarify the type of advice as being fiduciary in nature. FINRA and the SEC issued a joint warning on Robo advisors in May of 2015 saying the services often overgeneralize and make assumptions that do not assess your particular circumstances. The issue is really the willingness to accept the mantle of acting in a client's best interest at all times and whether what you receive from a Robo can be quantified as such. I think that this is a broader question of whether an investment advisor, Robo or not, is actually fulfilling their responsibilities of gathering and monitoring an individual's financial situation and investment objectives.
Regarding DALBAR
Dalbar certainly has its issues. As I mentioned, there are many factors involved in its computation, making the behavioral gap smaller than most portray it. I'm not even suggesting that the addition of a human advisor can automatically prevent such behavioral tendencies. I believe that Jim has accurately suggested, “there is no perfect advisor“. I was only addressing the fact that emotions play a role in investment success and I do not believe that Robo Advisors have the ability to adequately compensate for the behavioral gap in performance.
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What do you think? Do you use a roboadvisor? Why or why not? Which one do you use and why did you pick that one? Do you have concerns about a roboadvisor not being a fiduciary to you? Do you have concerns about not having someone to help you avoid bad investor behavior?
I spent a year with Personal Capital. While not technically a “robo advisor”, they do have an algorithmic approach which I consider to be similar to robo-advising. The main reason I joined was the potential for TLH. I moved a small portion of my assets just to experiment for a year.
I’m now in the process of moving all my assets back to Vanguard. TLH is extremely complex when you have assets at multiple institutions, and across multiple account types, thanks to wash sales. Just not worth the paperwork. Further, while I don’t micromanage my accounts, I do like to understand the transactions. At PC I was getting huge numbers of transactions that surely made sense to their algorithm but were too opaque for me. I can understand the abstraction of broad-based index funds. I have a tougher time with what seem like random dodges into and out of individual stocks across sectors. I understand their philosophy, but I prefer simplicity over incremental marginal returns. Finally, as you mentioned, a large portion of my assets are in accounts that couldn’t benefit from the algorithmic approach. So it’s not clear that I was ending up with a properly balanced portfolio.
I have talked to personal capital but decided against it because it was too expensive. They quoted me an AUM fee of 0.75 on 5 million. I moved the money to Vanguard and got one of their free financial plans. I followed some advice and ignored the rest. I basically manage the money myself and plan to use the personal advisor service when I don’t think I can any more. If my math is right this has saved me $97500 in advisor fees.
This will be obvious to many who read this site, but it is not to many less-sophisticated consumers, and I’m sure WCI has addressed it elsewhere. The term “financial advisor” is too broadly used and thus confusing. Salespeople who are remunerated by commissions and firms that make a lot of money from mutual fund 12b-1 fees cannot be relied upon to operate in the customer’s best interests. That’s one reason why vetting the potential advisor is so important. That said, robo advisors are worth considering for any of us, if only because we get a disinterested analysis of portfolios. I have reservations, though, about any company that offers its own ETFs and a robo advisor, as there is a pretty clear conflict of interest. Eventually, when I admit my cognitive powers are declining, I probably will move to some type of advisor, after considering not only the foregoing points, but also the qualities of individual advisors and firms available. I will interview Vanguard first, but I am distressed by their obvious bias toward their own funds (but against their own managed funds, some of which are excellent). In the end, I may just throw in the towel and settled on a handful of broad-based indexed instruments, no advising needed.
I have debated trying betterment and that backdoor roth button is very appealing. I know it has been laid out extensively in the past but I have not brought myself to actually do the backdoor roth yet. Paying 0.15% and getting it done quickly would be better than not paying 0.15% and not doing it. I realize that I should just do it myself and pay nothing but I have been lazy…
As evidenced clearly by my prior guest post and my comments I’m a fan of Betterment (no financial affiliation other than being a fee-paying customer of theirs). In addition to being reasonable their portfolio is more complex than I’d sign up for were I managing and balancing it myself. That plus the tax loss harvesting make the 0.15-0.25% fee totally worth it to me.
https://www.betterment.com/portfolio/
Regarding portfolios note the lack of cash holdings. Schwab has a high cash drag in all of their variously allocated portfolios, iirc, and that’s a sign that they’re skimming money off of you as they get the interest on that idle cash, not you.
Is this similar to Financial Engines? I get this free through Vanguard and have use them for over 10 years. I love it.
Tina
I have a small fraction of my portfolio, very small, like 0.7% small, and I add to it twice per month with cash flow from my checking account. I think it is a great, cheap, effortless way to get automated diversification and TLH. I wish that it had been around when I was getting started, 20 years ago. These services will continue to get better over time.
BTW, I do not consider Motif to be a roboadvisor, at least not in the same way that the others are.
My wife has 1500 from an old 401k that was converted into an IRA with raymond james a couple years ago after I met with a financial advisor but I think I would rather just move that to betterment account to do the backdoor roth conversion. Are there any rules I need to know about or can I just use the transfer funds in betterment and then fund the remaining 9500 into the IRA before converting to a backdoor?
You’re not convincing me that you understand how a backdoor Roth works. A Roth conversion is not necessarily a backdoor Roth IRA contribution. When you convert an old 401(k), you pay taxes on it. If you just roll it over into an IRA, you don’t pay taxes but it screws up backdoor Roth IRA contributions. Conversions don’t count toward contributions. Contribution limits are $5500 per person per year unless over 50, then it’s $6500 per person per year. I hope I answered your question in there somewhere.
I admit that I do not completely understand it which is why I was just going to let betterment do it for me. I was trying to figure out what to do with that $1500 that is currently sitting in a traditional IRA account (that was rolled over from an old 401k). I knew that since I already had money sitting in an IRA it would screw up the backdoor Roth conversion – I was trying to figure out the solution.
Ideally I would like to get the full 11k in a backdoor roth for my wife and myself this year but was trying to find a solution with the traditional IRA that my wife already has.
Throughout this article (even before the second half) I was thinking about WCI con #2, why not just do your investing for free?
The more complex you get with investing the worse off you become, and if you going to keep it simple then the advice is readily available without a robo advisor. No matter what your situation is, someone else has gone through it.
Also about a fiduciary …in the us is there some certification etc. where I can tell if they are a legit fiduciary? Every time I talk with a financial advisor I ask if they are one and they say yes and proceed to give me bad / selfish advice. So is the term fiduciary meaningful?
The only time I considered hireing an advisor, the person said they specialize in doctors, but when we started talking details about loan consolidation he said that he only worked with one loan consolidation company, I should roll my credit card debt into that (even though at the time I could have potentially taken a tax deduction), and he always misspelled my wife’s name even throug I spelled it in every email (not a huge deal but it didn’t exactly inspire confidence that I was dealing with a detail oriented person). This guy was a fiduciary.
Re: your question about a “legit” fiduciary”. You should ask the purported fiduciary if (s)he is a member of the largest association of fee-only advisors, NAPFA. Not all are, but I believe it generally an indication of an advisor who is highly motivated and committed to the responsibilities of a fiduciary. To be a member of NAPFA, we must sign a fiduciary oath, submit 60 hours of CE every 2 years, be a CERTIFIED FINANCIAL PLANNER PROFESSIONAL (they request that we use all caps!), and submit a comprehensive financial plan that is reviewed in depth.
The thing about a financial advisor is that you need to know 2 things… Are they competent and are they trustworthy.
NAPFA sounds good but I still get the sense that the term fiduciary is not like “Doctor” or “Lawyer” which not only have years worth of training and certification but also have to take an oath with bodies enforcing guild standards and ethics. If I say I’m a doctor and I am not, that’s fraud …although I am not a lawyer so I may be mistaken :). But there is nothing like that with a fiduciary (as far as I know). So I am starting to think the term isn’t that meaningful and you never really know if they have your best interests at heart even if they say they are a fiduciary
Guy makes some good points. Financial services are riddled with conflicts of interest. Pulling a Bernie Madoff unlikely… but lots of household names have been bankrupted or gone away altogether in part due to conflicts of interest and poor fiduciary practices. Notably Lehman Bothers, Bear Stearn’s, Merrill Lynch
https://en.wikipedia.org/wiki/List_of_banks_acquired_or_bankrupted_during_the_Great_Recession
It’s easy to cast dispersions during a long standing bull market. When the tide goes out, we frequently see the impact of what appear to be minor conflicts of interest. WCI does a good job with educational content but it looks like the first blog post was in May of 2011. Statements like “their own “ETF’s are pretty much all fine”, “not a bad one in the bunch” and “they will be around longer than any human advisor” are a bit reckless coming from an entity that hasn’t been around through a full market cycle. Probably bordering on advice as well, considering there seems to be compensation being generated from some of the listed Robo’s here, even if conflicts have been disclosed.
To be fair, Betterment basically puts you in an age appropriate asset allocation, whereas a financial advisor sitting across the table from a neurotic, ultra-risk averse investor might have a hard time gettng them to a 60% equity allocation and keeping them in it. The Betterment investor would freak the first time the market dropped and pull everything. The 5.7x’s fee would be worth it in that case. I feel like robo-advisors are best used by people who somewhat know what they are doing, paradoxically.
Is there any evidence that financial advisors are less susceptible to the behavioral biases than the average investor? It seems to be taken for granted that your advisor is going to be able to coolly stare down a bear market while their clients are panicking.
You know, wisebanyan.com is a free robo-advisor. And not “free” like Schwab where you have cash drag, but truly free. What’s the catch? There’s no free tax-loss harvesting (although you can opt in for that for 0.25%, and it is limited to max $20/month, and it only gets charged to your taxable account, as opposed to 0.15% to your entire account at Betterment). And you have to like their allocation. Also, they have very small assets under management so they may go bottom up in a few years. Since there’s no sound business plan, that’s probably why WCI won’t get paid for referrals. But I count myself as a true Boglehead and have been DIY for > 10 years and quite honestly, a robo-advisor is more for the convenience than anything else, especially for people still accumulating. I truly hope they survive, if only since I don’t want to pay Betterment 0.15%. FWIW, I’m not even going to post my referral link here (but if you actually want it, let me know.
This is actually my (old) post from bogleheads a while back that compares some of the robo-advisors. There’s a GoogleDoc that I made that lists the ETFs, fees, etc. It hasn’t been updated in a while, but you may find it useful
https://www.bogleheads.org/forum/viewtopic.php?t=160555&start=200#p2420538