by: Gabe Jacobson, Associate

Robo-Advisors are a recent invention of the financial services industry. At first only start-ups offered these services. Two of these startups from the past decade, Betterment and Wealthfront, now have over ten billion dollars in assets under management. Since that time, traditional major players in the brokerage and financial management industry have entered the market. For example, Charles Schwab’s robo offering is called Schwab Intelligent Portfolios. Vanguard has a product called Vanguard Digital Advisor, and Merrill (formerly Merrill Lynch) offers a robo product called Merrill Guided Investing.

Signing up for a Robo-Advisor is similar to creating an online brokerage account. You will need to provide personal and financial information through the online platform to deposit funds into the account. Once the account is created the software will ask you similar questions to what an actual wealth manager would ask, but in the form of a multiple-choice survey you take through the online platform. The questions typically include your current age and the age you expect to retire at, how much social security you expect to collect when you become eligible, and your level of risk aversion. Some Robo-Advisors will ask about other financial goals, such as when you intend to buy a house or send your kids to college, how much money you expect to need for these expenses, and how much you expect to spend annually during retirement. However, some Robo-Advisors hide planning tools such as these behind additional fees.

Robo-Advisors can help reduce investors’ total costs. Annual advisory fees that average 0.25% of client funds under management. There is an additional expense for each ETF within the automated portfolio that typically ranges from 0.05% to 0.2%. In most cases, there is not a transaction charge but there may be fees for additional services.

Most Robo-Advisors offer differing levels of service and account types at varying price points, but few have the same pricing structure and service offerings making it a challenge to comparison shop. For example, many allow you to open a normal taxable investment account, a traditional IRA, or a Roth IRA, but not always for the same fee. The taxable accounts can generate taxable gains, so some Robo-Advisors offer automated tax-loss harvesting services at an additional fee. Robo-Advisor account minimums are typically between zero and five thousand dollars, making them accessible to almost everyone. This pricing is roughly one quarter the cost of other forms of active portfolio management. However, frugal investors should be wary of less explicit fees. For example, Schwab Intelligent Portfolios charges no annual fee, but their automatic account allocation takes between six and fifteen percent of client funds and holds it in cash. Schwab explains in their marketing that they “believe cash is a key component of an investment portfolio,” so “a portion of your portfolio is placed in an FDIC-insured deposit at Schwab Bank.” Unfortunately, this account offers below market interest yield compared to competitors cash saving accounts, and no debit card or checkbook is provided, so the cash is effectively a drag to the investor.

Previously I mentioned that Robo-Advisors invest in ETFs that carry their own expenses. Investors should know that some Robo-Advisors use their own proprietary ETFs and earn both the investment expense and the advisor fee. For example, Schwab Intelligent Portfolios invests predominantly in Schwab ETFs, which they directly profit from. A number of other companies who offer Robo-Advisor services also offer proprietary ETFs. These details may not be easily discernable to novice investors who could be drawn to zero or low fee marketing campaigns. Clearly, a considerable amount of research is required to decide on a Robo-Advisor. Many investors may prefer to spend that time researching actual stocks, bonds, or ETFs to invest in.

As mentioned earlier, investors considering Robo-Advisors may also want to evaluate full-service wealth managers and do it yourself brokerage accounts. Full-service wealth managers cannot easily be grouped, but they typically have account minimums between $1 million and $5 million and charge annual fees that average 1% of client funds under management. These advisors work with clients on a one-on-one basis and consider investment choices in the context of personal financial circumstances.

For these reasons, frugal investors with limited funds to invest are likely deciding between do-it-yourself brokerage accounts and Robo-advisors. Opening a brokerage account at firms such as Vanguard, Fidelity, or Charles Schwab, enables investors looking to create a passive portfolio to utilize a wide variety of ETFs and mutual funds that are well diversified and track various market indexes. In addition, most of these brokerages offer easy-to-use target-date mutual funds, which shift asset allocation over the life of the investor away from faster growing riskier investments toward less risky investments that pay dividends during retirement. These target-date funds on average have expense ratios, or fees, of 0.78% of the investment.

In summary, for frugal investors looking to invest passively, Robo-advisors offer tremendous value compared to full-service wealth managers and allow greater flexibility than target-date funds. However, picking the right Robo-Advisor may require an investor to do a lot of research. Investors may want to spend that time educating themselves about investing and save on fees in the long term by opening a do-it-yourself online brokerage account.