Every investor who’s fired a bad advisor and become a do-it-yourselfer has probably had mixed feelings. On one hand, it’s liberating to get away from a costly strategy that was performing poorly. But if you’ve never managed your own portfolio, it won’t take long to realize it’s not as simple as you first thought. In the last couple of years a growing number of US investors has been bridging that gap with online services that design, implement and manage ETF portfolios for a fraction of the cost of a human advisor.
These so-called “robo-advisors” take you through a series of questions to determine your goals and your risk tolerance and then build a diversified portfolio using an appropriate mix of equity and bond ETFs. The service looks after rebalancing and reinvestment of dividends: all you do is contribute regularly and the software does the rest. Wealthfront, which bills itself as “the largest and fastest growing software-based financial advisor,” even includes tax-loss harvesting for accounts over $100,000.
The cost for all of this? At Wealthfront you can invest your first $10,000 for free, after which the fee is 0.25% annually. Its largest competitor, Betterment, charges 0.35% on balances under $10,000, 0.25% between $10,000 and $100,000, and 0.15% thereafter. This includes all transaction costs, but not the management fees on the underlying ETFs, which add another 0.15% or so to the price tag.
For the right investor, it’s difficult to imagine a better solution. A good advisor can add a lot of value for clients with large portfolios (especially in taxable accounts), as well as those who need planning services. But there’s a huge number of families with five-figure RRSPs who don’t need the services of an advisor—and they aren’t getting attention from their advisor even if they have one. Many are paying 2% or more for rotten portfolios and nonexistent service. While it’s easy to tell them to become DIYers, the truth is most are not capable of effectively managing an ETF portfolio on their own. A software-based solution could cut their fees by 75% and deliver better results with minimal effort.
Even savvier investors would benefit from services like Wealthfront and Betterment: sure, they could save 0.25% or so by building and maintaining their own ETF portfolio, but there is a huge behavioral advantage to automating your investment plan. Although making regular monthly deposits and periodically rebalancing a portfolio sounds simple, most people are temperamentally incapable of doing so. (There is ample evidence to demonstrate this, and my e-mail inbox would corroborate it.) I’d estimate the discipline imposed by a robo-advisor would easily add 0.25% to what most DIYers would get using the exact same portfolio.
Unfortunately, there’s nothing like Wealthfront or Betterment in Canada. Will we ever see something similar in this country?
A daunting challenge
I’ve spent a lot of time thinking about the robo-advisor model and discussing it with colleagues. As much as I love the idea, it’s hard to see how it could ever be a viable business in Canada. Wealthfront launched late in 2011 and recently crossed $500 million in assets. While that’s a lot of money to you and me, when your fee is just 0.25% it works out to gross revenues of $1.25 million annually. Not chump change by any stretch, but it’s not even enough to pay for overhead and salaries.
Yes, it takes time for any start-up to turn a profit, and Wealthfront claims 450% growth in 2013, so it’s very possible the business will become lucrative in the future. But the robo-advisor business has extremely low margins and can only survive by building enormous scale. In a country with a population ten times smaller than the US, how can an online financial advisor ever do that?
My guess is the vast majority of robo-advisor clients have four- and five-figure portfolios. If these investors are paying 0.25%, their fees aren’t even covering the cost of the paperwork. The most profitable way to build scale in the investment management business is to go after high-net-worth clients. But investors with large portfolios aren’t likely to be attracted to generic software-based solutions: they’re much more likely to recognize the value of paying a professional for good advice tailored to their individual needs. They also have access to the best advisors and the lowest fees already.
There is one advantage robo-advisors would have in Canada: fewer good alternatives. American investors with as little as $1,000 can already go to Vanguard and buy a target retirement fund for 0.16% to 0.18% annually. So Wealthfront and Betterment will have to wrest assets away from a juggernaut with even lower costs. In Canada, robo-advisors would face far less worthy competition and might be able to grab a bigger share of the DIY investor market.
Unfortunately, I have to conclude that software-based portfolio management isn’t likely to become a reality in this country. But I sincerely hope there’s an entrepreneur out there who will prove me wrong.
@Paul – I don’t need external management. I do everything myself like many who follow this blog. I doubt I spend more than 10 min/mos on my portfolio and 9 minutes of that is depositing cheques. But most people do. use external management. If they did there wouldn’t be over 100,000 financial advisors, brokers, money managers, etc in Canada (and that excludes support staff).
I never suggested a sliding scale would make or break the business but, in fact, alluded to it being appropriate. Also, my analysis did not pertain to companies that offer other products, but I would suggest that a prudent money manager would make sure that each service they provide stands on its own as a profit centre. Also, not all money managers are full service and so they would not have other profit streams to draw upon in order to reduce fees on other services which to make doesn’t make much business sense anyway unless you need to do it to attract clients. And, if you not what you are doing you don’t need to offer such loss leaders.
You can harp all you want that the fees should be lower, but the fact is that if you want someone to create and manage your passive index portfolio on an ongoing basis then you have to pay up and in Canada that currently is about 1% for an amount up to where a sliding scale kicks in. Neither you nor I would pay that fee as we invested the time to be knowledgeable enough and have the will to do it ourselves, but many feel it is worthwhile to pay the fee and if I was in their shoes with their different inclination I would too. The simple fact is many feel it is worth paying the fee for not to have to do anything.
And yes there is a trend, but that trend is a very very slow one. I remember reading about index investing for the first time in the 80’s and read articles about this being the new trend, etc. And, 30 years later. where are we? Not anywhere close to it being a groundswell torwards passive index investing. It may seem that way if you constantly read blog articles about index investing and have bought into it, but the reality is a small percentage of people have, and even a tinier percentage that do it on their own.
As for what a 75 basis point difference does to a portfolio over a 25-year period I am well aware of that. However, even if you show the difference to people the majority will say “What do I do now?” and if you tell them to go through the whole exercise of educating themselves and investing on their own they will say no thanks and if an advisor like PWL presents themselves they will jump at the chance to just pay someone so they don’t have to do it it themselves. It’s just human nature.
Most people are scared of investing and all the dancing around and telling them that they can do passive index investing on their own serves no useful purpose 95% of the time. And that’s for the 1% that hear about it. The rest never even find out there is another world out there.
Yes it’s changing…at a s n a i l ‘ s p a c e
I managed my own account from 1984 through 1999 and did quite well even though I had everything in mutual funds. I thought an advisor could do better for me so I went with a full service advisor from 1999 until 2008. His fees were 1.75% per annum. That is also very close to my annual TRs for the period. I had enough and went back to DIY in 2008. Since then I’ve been averaging 12% per year even with the -22% drop in 2008 factored in. Can’t complain now although I’d have 200-300K more if I had remained DIY all along!
The robo-advisory market seems to be gaining traction.
Today, Wealthfront raised $64m of Series D capital (and CEO notes ‘We never even spent a dollar of last round’ [being $35m Series C raised earlier in 2014).
Also today, Schwab announced a free robo-advisory service for launch in Q1 2015.
Robo-advisors may not appropriate be for everyone. But it certainly seems that the consumer may soon be blessed with greater number, and increased quality, of choices as the advisory market further segments. Canadian incumbents may kick-and-scream (https://canadiancouchpotato.com/2013/08/27/will-mutual-fund-advisors-soon-be-selling-etfs/) but risk being ever less competitive, from an already lamentable position (http://corporate.morningstar.com/US/asp/subject.aspx?xmlfile=374.xml&filter=3081).
It will be a while until robo’s are allowed in Ontario (and Canada for that matter) as the the latest OSC Staff Notice states: ‘We do not think that an entirely automated decision making process is acceptable at this stage’. And in case you have not noticed, the OSC moves VERY slowly.
Wealthfront has raised 132.5M so far in their 4 rounds of financing since they began in 2008.They say ‘$1 Billion. Two and a Half-Years’ on the front page of their website but the real picture is that they gathered an additional $1B in assets under management in that period but it took almost 6 years to get there as they didn’t have much traction until 2-1/2 years ago.That translates into $2.5M in fees per year.
They are being prudent in raising the money even though they don’t need it because you raise it when you can and not when you absolutely have to. Who knows how long the current favourable market for those looking for venture capital will be and with revenue of only $2.5M+ in 6 years (and for sure not profitable) you likely are going to need more capital.
Has there been an update on the Robo investing. I am interested. It seems that Wealthfront has proven himself. What is holding the canadian side of the business?