Why We Say No To Robo-Advisers
Last week,my dad brought the most recent issue of Consumer Reports with an article about investing to my attention (I’ve created a monster!). The article focuses on “The Rise of the Robo-Adviser”. My dad wanted my opinion on whether a robo-adviser is better than what we are doing with Vanguard.
As is their reputation, Consumer Reports gave a straightforward, unbiased assessment. The gist of the article is that robo-advisers can offer substantial cost savings compared to the fees of traditional advisers. A good human adviser can bring value by mitigating behavior and giving a more comprehensive picture of your financial situation compared to robo-advisers. The consumer must decide what is best for them.
Where I think the article missed the boat is by starting with the assumption that investing has to be complicated and so we need some type of help. Mrs EE and I felt investing was complicated and we needed help most of our adult lives. This is why we started with an adviser. This is also why I am such a big fan of JL Collins and have always promoted his “Stock Series” and more recently his book “The Simple Path to Wealth” for his ability to simplify the complex.
If you do not accept the premises that investing has to be difficult and that you need help, you can change the entire conversation. Instead, we can make a full comparison between traditional adviser, robo-adviser, or do it yourself (DIY).
My approach to all investing related decisions is that I can control 3 variables:
- Cost (trading fees, loads, expense ratios, etc)
- Taxes (timing of income taxes, capital gains taxes, etc)
- Behavior (greed, panic, amount of risk accepted, etc.)
Below is my expanded analysis of the Consumer Reports article comparing robo-advisers to traditional human advisers. I will then show why we think it is best to just DIY.
As the article points out, robo-advisers offer substantial savings compared to traditional advisers. All in costs average .25-.5% with robos compared to 1-2% with traditional advisers. However,you can cut the even low costs of robos by 50% or more if you are willing to DIY. Our DIY portfolio has a current weighted expense ratio of .13%. Once we are able to consolidate our work related accounts into our Vanguard investments it will be less than .1%. The hands down winner for cost is to DIY.
While cost is very important when investing, of even more importance is value. Can advisers bring value with tax savings or behavioral modification that justify their expense?
Robo-advisers tout the use of tax-efficient exchange traded funds (ETFs) and the use of tax-loss harvesting to build a tax efficient portfolio that justifies using their services. Can you really expect these features to outweigh the cost of the services?
ETFs are far more tax friendly (and less expensive) than actively managed funds which tend to be pushed by traditional advisers. However, an even more important decision than what investment product you use is where you house your investments. It may be of far greater tax advantage to simply invest in a work related account such as a 401(k). In 401(k) or other work related plans, you are limited to the investment options in your particular plan. Most plans include at least a few low-cost, tax-efficient index funds or ETFs anyways. This means you can have the best of all worlds without the added expense of the robo-adviser.
Robos also tout tax loss harvesting as a benefit of their services. However, this benefit is more sales pitch than value in reality. Harvesting is only a benefit for taxable accounts, yet the same fee is charged even if you have money in an IRA, Roth IRA, rollover, etc where there is zero benefit in harvesting. In reality, this is where the majority of people hold the majority of their investments.
Tax loss harvesting is also an overstated benefit even in taxable accounts. It is essentially a tax-deferral strategy. It may be great in some situations (high-earning working years), but may actually be detrimental to others (low earners early in their careers or low income retirees). Without a comprehensive financial plan, a robo could not know any of this.
A knowledgeable human adviser could be worth their fees if they gave good tax advice. However, advisors also have many conflicts of interest to not give good tax advice as was our experience outlined here and here and here and here. You really do not know if you are getting good or bad advice unless you take the time to educate yourself.
Tax planning can have a massive effect on the time it takes to reach financial independence. Both robo-advisers and human advisers will try to sell you on the tax advantages of their services. Both will sell you half-truths. There is unfortunately no short-cut to getting maximal tax benefits without sitting down and understanding the taxation of earned income and investment income and figuring out how to apply this information to your personal situation.
Professional tax planning advice can provide value that outweighs cost. However, you are far more likely to find this value by paying to consult with a knowledgeable tax professional (attorney, CPA, or fee only adviser) periodically as needed rather than paying ongoing fees to an adviser (robo or human) for advice that is likely incomplete and conflicted.
Since we have elected to DIY, we have developed an extremely simple tax strategy. We max out all tax-deferred investment options first. We then max out Roth IRAs. Last we invest in taxable accounts. In the taxable accounts, we use asset location to keep only index funds with extremely low turnover. We then do all re-balancing in tax advantaged accounts. Doing this, we have an extremely diverse and tax-efficient portfolio. We have no additional cost and little ongoing thought or effort. DIY is clearly the best decision for us with regards to taxes.
Behavior is the biggest factor in your success or failure as an investor. Robo-advisers can automate investing and periodically re-balance accounts. However, these same features are available with Vanguard, my 401(k) provider, and I assume most, if not all, other brokerage services for free. I see no value in a robo-adviser if you are prone to greed and panic that cause most people to under-perform the asset classes that they invest in by buying high, selling low and over trading.
Talking people off a ledge when markets are dropping is the primary benefit I see in a traditional financial advisor. Making only one big mistake and selling in panic in a major downturn like the one experienced in 2008 could be devastating to a person’s wealth. However, this behavior modification comes at a steep, recurring price even if you have a good adviser. Is it worth paying high fees every year to have access to someone to call when things go sideways? It is an important question to answer correctly. A wrong answer (yes or no) would be very costly. We each have to take a long look in the mirror and make an accurate self-assessment.
We feel very confident the process of educating ourselves to build our portfolio to become DIY investors has simultaneously given us understanding of the volatility and expectations of our investments. This will allow us to control our behavior when we most need to. Developing our own investment plan as part of our overall financial strategy and incorporating an appropriate amount of risk also makes panic unlikely for us. Having a written plan that is developed with reason and logic in calm times and then following it in times when others are ruled by greed, fear, or panic also helps immensely.
No Robo For Us
Looking at the situation objectively, I think that the clear cut best option is to become a DIY investor. There is potential value to be had from an adviser (human or robo). However, both will cost more than the DIY option and both come with their own downfalls, conflicts of interest, and overstated sales pitches. The only way to know if you have found a good adviser and strategy, is to go into the process educated. Once you have the knowledge to make educated decisions, you have enough knowledge to simply DIY.
Some people will disagree, which is fine. If you go in as an informed consumer and feel that it is of value to have an adviser, robo or human, more power to you. This post is written more for those that insist you do not have the time to educate yourself or think it is just too hard. If you are willing to blindly trust your money to a person or computer,….well….., GOOD LUCK!
For different insights but the same conclusion about robo-advisers, check out this excellent read from Go Curry Cracker. Jeremy shares “Why Betterment Has Zero of Our Dollars”.
Do you still use an adviser (human or robo)? If not, do you agree that it is pretty simple to DIY? If you use an adviser, what do you find valuable and how do you know if you are getting good or bad advice? Share your thoughts below.
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