Are robo-advisors the wave of the future? Research from management consultant firm A.T. Kearney suggests so: According to its number crunching, robo-advisors will manage $2 trillion in assets in the U.S. by 2020.
That’s rapid growth. To put it in perspective, two of the biggest robos, Betterment and Wealthfront, currently manage $7 billion and $4 billion, respectively. They’re bringing financial advice to the masses by charging rock-bottom management fees for customized asset allocation, automatic rebalancing and tax-loss harvesting.
If you’re thinking of joining in on that momentum, the first step is deciding which online advisor is best for you. It’s an increasingly crowded field, with options that range from complete automation — robo-advisors in the true sense of the word — to hybrids that pair computer algorithms with dedicated financial advisors. To narrow it down, consider the following criteria:
Online advisors typically charge an annual management fee that is assessed as a percentage of your invested assets. That percentage ranges from zero (hats off to you, WiseBanyan) to 0.89% for services like Personal Capital, which operates under the aforementioned hybrid model in which each client gets a financial advisor in addition to computer monitoring of investments.
Some advisors, like Wealthfront and SigFig, manage the first $10,000 of assets for free. If you have only a small amount to invest, you might consider starting there. Robo-advisors generally don’t charge account closing fees, so you can always move your money when your balance qualifies you for a lower fee elsewhere.
You may be wondering why this post isn’t over: Why wouldn’t everyone pick WiseBanyan, if it’s completely free? The answer is that fees are just one piece of the online advisor puzzle. You also want to consider what sort of service the advisor provides: automatic rebalancing, tax-loss harvesting and easy rollovers (in case you want to move an old 401(k)) should come standard. Some advisors also offer other perks, like Wealthfront’s direct-indexing option, which allows an even bigger tax advantage by investing in individual securities, and Betterment’s goal-based system, which lets investors to set up different accounts and auto-deposits based on goals.
This is where WiseBanyan comes up a bit short: its model is to offer free management, but paid extras. Automatic rebalancing is included, but tax-loss harvesting comes with a fee. Bottom line: It’s important to assess your priorities and weigh them against the management costs of the online advisor. Some things are worth paying for.
Management fees are just one cost here; the investments used to build your portfolio will also have underlying expenses. Most robo-advisors invest exclusively in exchange traded funds, with expense ratios that generally average under 0.20%. This keeps investment costs down, which can make a big impact over the long run: Mutual fund expense ratios averaged 70 basis points in 2014, according to the Investment Company Institute. The difference between an investment with a 0.70% expense ratio and one with a 0.12% expense ratio could mean over $145,000 on a $100,000 investment over 30 years.
When evaluating online advisors, look at the total cost — management fees plus average expense ratios — to get a full picture of what is coming out of your wallet. Charles Schwab, for instance, has an online advising service called Schwab Intelligent Portfolios that features no management fees. Investors will still pay investment costs: Schwab says the weighted average of expenses in their portfolios ranges from 0.12% for a conservative portfolio to 0.25% for an aggressive one. The low side of that range is hard to beat; the high side could be comparable to what you’d pay at Betterment for management and expense ratios with a $100,000 portfolio.
If you don’t want to invest in ETFs, you’ll want to look at online advisors that offer more customization of client portfolios, like Vanguard Personal Advisor Services and Personal Capital. Keep in mind that these will come with higher-than-average online advisor management fees.
Online advisors have account minimums ranging from $0 to as much as $100,000, so this is a key component of the decision process. If you are starting fresh, you’ll want to look for an advisor with a low barrier of entry, like Betterment or WiseBanyan (both have no minimum). In general, the greater level of personalized service (like a dedicated financial advisor), the higher the minimum initial investment.
With the exception of Blooom, which specifically deals in 401(k)s, most online advisors cater to IRAs and taxable accounts. If you have a 401(k) that offers matching dollars, you want to prioritize that account first, because that match is a guaranteed return on your investment. Once you’ve captured the match, you can consider opening an IRA with an online advisor. Taxable accounts at online advisors should be used if you’ve maxed out your 401(k) and IRA contributions, or for longer-term savings goals, like a home downpayment.
There’s likely an online advisor out there for every investor, and there’s no doubt more will enter the fray in the coming years. When surveying the field, be sure to carefully consider your priorities, including factors like fees, access to personalized financial advice and investment minimums.
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