The Robo Advisor Rundown (Project: Account consolidation Part II - Where to invest)

In my last post, I talked about a project I’m working on to consolidate my financial accounts. My goal is to spend less time tracking what is where and more time thinking strategically about my entire portfolio. A critical step in that process is deciding where to consolidate those accounts, so here I’ll summarize the research I’ve done to make that decision.

I mentioned my preference for a passive investment strategy in a past post on putting idle cash to work. I also shared how I liked Vanguard funds as well as a new-ish category of algorithm-driven investment advisors called “robo advisors” as a means of executing on that passive strategy. The reason I like robo advisors is that they will figure out your asset allocation for you and will then handle portfolio rebalancing and tax optimization. It allows me to be pretty hands off, without having to work with a traditional financial advisor who would charge a lot more. Up to this point, I've been investing with a couple of different robo advisors to feel them out a bit. Now that I've decided to consolidate and might increase the money I let them manage, I decided to do a bit more scrutiny.

One thing to note is that I didn’t look every robo advisor out there. I concentrated on Betterment and Wealthfront as two of the larger start-ups in the category, Personal Capital which has interesting tools and a human advisor component, and the robo offerings that Schwab and Vanguard recently launched.

Here’s an overview of the robo advisor landscape from my perspective:

Wealthfront: a low friction, low cost way to get in the game

Wealthfront’s offer is pretty straightforward which makes it easy to start investing instead of sitting on the sidelines. They’ll use a model to generate a recommended asset allocation for you, build that portfolio out by buying into 7-8 ETFs (stocks, bonds, alternatives) on your behalf, rebalance the portfolio when necessary and take advantage of tax loss harvesting opportunities for you. They'll manage your first $10K for free (though you still pay the normal ETF fees) and the basic tax loss harvesting service is available for all accounts. I really like how it’s easy to see your account balance as compared to the deposits you have made, so you know if your balance is going up because of market performance or because of the money you’ve put in lately. I've found that this particular view of my investments to be surprisingly hard to come by with other services I've used in the past. 

Betterment: a goal-based lens on investing that’s helpful but limited

Betterment offers a lot of the same funds as Wealthfront, though they intentionally avoid alternatives (real estate funds and commodities) because they do not believe they’re a good bet for diversification or hedging against inflation. They also offer Large/Mid/Small Cap value equity funds, which Wealthfront does not. They approach building your portfolio through the lens of your financial goals. So if you tell them you want to have $150K in 15 years for college, they’ll calculate how much you need to save each month and how you should invest those funds to get there. Then they’ll automate the transfer of funds from your bank account to your Betterment account where it will get invested. It’s a very cool calculator, especially the RetireGuide portion, but the experience around external accounts was pretty disconnected which made their system seem a lot less useful to me. I was able to use external account information to calculate my retirement savings needs, but all of the tracking after that focused only on Betterment accounts. This incomplete picture made it hard to see how I was really doing in tracking towards my goals. Otherwise the service seems pretty solid. 

Personal Capital: awesome free tools, expensive advisory service

There are three components that drive Personal Capital’s recommendations: data they gather about you from their tools, their investment model, and input from a human advisor. They try to differentiate themselves from the pack through that human advisor who can offer guidance on a variety of financial planning topics. However, I have found that service to more of a helpful reference point than a true substitute for a financial planner. Personal Capital also differs in the assets they use to construct their portfolios. With the US stock component, instead of buying ETFs, they create their own index from >72 individual stocks to support their philosophy of equal sector and style weighting. This supposedly gives you better value for less risk. While you’re paying a premium over other robos for their investment services, they do have some great free digital tools. I really like how you can pull in all of your accounts and then view that data in different ways. You can see your overall portfolio asset allocation, calculate whether you’re on track to save for retirement, assess fees that you’re paying, etc. At minimum it's worth checking out their free tools.

Vanguard Personal Advisor: hand holding to implement Vanguard’s philosophy

Vanguard’s service gives you access to an advisor who will help you implement Vanguard’s philosophy. In a nutshell, that philosophy is to: set goals, diversify your investments very broadly, keep it inexpensive and stick with it for the long haul. The majority of your portfolio is going to be invested in very broad based index funds (domestic/international total stock and total bond funds) so you have to be bought into the idea that owning the entire market for the long term is the way to go. The advisor you work with will help you determine your initial asset allocation based on your goals and will check in with you periodically. The more money you hold with them, the more personalized attention you’ll get. They only offer advice on topics related to your investments. So they could help you understand the differences between, say, a Roth 401(k) versus a Traditional IRA, but they wouldn’t give you perspective on stuff like insurance or estate planning.

Schwab Intelligent Portfolios: Is free too good to be true? Yeah, maybe.

Schwab’s big standout feature is that they do not charge fees for the account services that you’d pay for with other robo advisors, like asset allocation, portfolio rebalancing and tax loss harvesting. The underlying funds that you will be invested in still come with fees, but that’s going to be true of any robo advisor you choose. The big caveat with Schwab...and for me this was a deal breaker...is that they make money from the underlying assets in your portfolio, both the ETFs and the cash. Actually it’s really just the cash part that bothers me, because the fees on the ETFs seem in line with what you’d pay elsewhere. No matter how I answered their portfolio allocation questionnaire, I couldn’t get the cash allocation to ever dip below 6%, even when the tool was recommending the other 94% be invested in stocks. This made me really skeptical about whether Schwab’s incentives were really aligned with mine.

My search didn't turn up the one perfect solution, but I do think there's a lot to be said for just getting started somewhere. If you have thoughts to share, please leave them in the comments as I'd be interested in hearing other people's perspectives, especially if you've tried these companies out. OK, now down into the weeds for those of you out there who like to geek out on the details... 

Here’s the criteria I used to compare these players:

Criteria Rationale
Assets Under Management (AUM) + Year established While size isn’t a predictor of the quality or future viability of the company, I felt more comfortable with players in the category who had a bit more of a track record.
Fees + Account minimums The account minimum is simply the ticket to entry. The fees that the provider charges add up quickly and translate to less money compounding in my account. Note that the funds you'll ultimately be investing in will also have related expenses that are not included in the robo advisor fees.
Investment options provided This is really the bread and butter of what the provider is doing for you - investing your money in different financial instruments. I wanted to understand what components each provider was working with to customize a portfolio for me.
Tax benefits offered Most offer some help with how to minimize the tax bill associated with the investments you hold with them. This matters less if you only plan to hold accounts where taxes on your earnings are deferred (401(k), IRA, 529, etc)
Asset allocation recommendation Each provider has to get to an initial recommendation of how to invest your portfolio among different types of assets (stocks, bonds, alternatives, etc.) I wanted to know how they got to that recommendation.
Portfolio rebalancing I wanted to understand what these players do when your portfolio inevitably drifts from that initial allocation because of fluctuations in the market.

Here’s how they each stack up against my criteria:

(All info as of Feb 2016) Betterment Wealthfront Personal Capital Vanguard Personal Advisor Schwab Intelligent Portfolios
AUM $3.2B ~$2.6B $1.5B $31B $4.1B
Year
established
August 2008 December 2012 July 2009 May 2015 May 2015
Account minimum $0 $500 $25,000 ($100K for more robust advisory service) $50,000 $5,000
Fees
(this doesn't include the expenses for the funds held in your portfolio)
0.35%
($0-$10K w/auto deposit)

0.25%
($10K - $100K)

0.15%
($100K+)
Free
($0-$10K)

0.25%
($10K+)
Free
(Analytics tools)

0.89%
($0-1M)

If you have >$1M invested, fees go down on a staggered schedule to as low as 0.49%
0.30%

Vanguard uses its own funds in your portfolio so they do stand to also make money on those funds. Since they're only using a few very broad based index funds, personally I didn't feel that the recommendation they made would be skewed to help them maximize their revenue.
No fees

Schwab makes money from both the funds and cash in your portfolio. Their funds generally seem pretty low cost, but as a novice investor, I couldn't really tell if the portfolio composition they recommended was more heavily weighted towards funds they'd make a larger profit on. I also questioned the cash recommendation I got. It seems to me you really are paying for their service but it's just harder to see.
Investment options Portfolios are invested in a mix of 12 ETFs. Details about their selection criteria are here. They notably make a point of avoiding alternatives (commodities and real estate) because they do not believe they’re a good bet for diversification or hedging against inflation. Their options are otherwise pretty similar to Wealthfront's, though they also offer Large/Mid/Small Cap value equity funds which Wealthfront does not. Portfolios are invested in a mix of 7-8 ETFs. Details about their selection criteria are here. They offer many of the same funds as Betterment (mostly Vanguard and iShares), but they differ in that they do inlcude natural resources and real estate funds. Portfolios are built from 5 asset categories: US stocks, international stocks, US bonds, international bonds, cash. Most categories are funds, but the US stock component is an index that PC builds from >72 individual stocks to support their philosophy of equal sector and style weighting.You can read more about it here, but basically they believe the more traditional approach of a capitalization-weighted index means you end up overexposed to large cap companies which could mean you’re overpaying and taking on more risk. Portfolios are built primarily with 4 very broad based Vanguard funds: total stock (domestic + international) and total bond (domestic and international). Portfolios might incorporate a couple of other index funds depending on the investor. 54 available exchange-traded funds – from Schwab and 10 other fund families representing 20 different asset classes, including stocks, bonds, emerging markets, real estate investment trusts (REITs) and commodities.
Tax benefits Tax Loss Harvesting for all accounts. They claim to have a better model for tax loss harvesting.You can read about it in detail here. Tax Loss Harvesting available for all accounts. “Tax-Optimized Direct Indexing” is available for accounts >$100,000 which they claim is even better. Advisers can help you think about how to strategically use taxable and tax-deferred accounts to minimize taxes. They seem to think the value of tax loss harvesting is over-hyped. Advisers can help you think about how to strategically use taxable and tax-deferred accounts to minimize taxes. They say tax loss harvesting isn’t a big focus because you’re buying and holding very broad based funds. Tax loss harvesting available for accounts with >$50K in assets.
Asset allocation recommendation Your recommendation is based on your age and the time horizon for a specific goal. They differentiate it from just being a Target Date Fund b/c you can customize your asset allocation and you can get advice on how changing parameters will help you meet your goal (e.g., retire later or save more per month) Your recommendation is based on a risk tolerance questionnaire and some investor profile information. They differentiate from being a Target Date Fund primarily because of the ability to customize risk tolerance, tax loss harvesting and the more diversified portfolio they offer. Your recommendation is based on risk tolerance assessment, investor profile data and info from a retirement planning tool on their site that helps identify goals and target savings required to hit those goals. It seems your data is fed into their model and then reviewed/adjusted by your advisor. Your recommendation is based on a conversation with an advisor about your goals, time horizon and risk tolerance. Unclear the role that technology is playing, but presumably your data is fed into a model and reviewed by an advisor. Your recommendation is developed through a 10-step questionnaire to determine your goals, time horizon, and risk profile.
Portfolio rebalancing Threshold of acceptable drift from target allocation is very transparent. They emphasize that they help you rebalance in a tax-efficient way. They monitor drift and rebalance in a tax-efficient manner on your behalf. Rebalancing thresholds aren’t stated as far as I could see. As a general rule, high-level asset classes are rebalanced if they deviate more than a few percentage points from target, while specific securities are reviewed if they move more than 0.5% from target. Taxes are strongly considered in the decision with a goal of keeping turnover under 15%. They rebalance for you when your portfolio has deviated more than 5% from your original allocation target. They automatically rebalances accounts that maintain a $5,000 balance.

For those of you who are curious, here's a bit about my research process on this topic. As a recovering management consultant, I treated this part of the project like the competitive assessments I used to do for clients. First I identified the players I wanted to compare and the criteria I wanted to use to assess them. Then I methodically filled in the blanks by reading a ton of articles, signing up for accounts and sometimes reaching out to the companies directly with questions. Lastly I did a brief executive summary for each player to call out the highlights of what I'd found.

Also please keep in mind that I'm sharing my opinions and that the data I have summarized could become outdated since the robo-advising market is evolving rapidly. I'm not an advisor and am not liable for information you might decide to use, but I do hope you will find this useful context.