Robo Advisors: Investment Management at a Discount
Mutual Funds Often Have a Cost Disadvantage
In my previous post, I wrote about several advantages of investing with mutual funds. That post invited a few comments about the costs of mutual funds outweighing the behavioural advantages. Although there are a relatively few mutual funds that are at the lower end of the cost spectrum, many mutual funds charge high fees. In the last year, I reviewed a portfolio for a client who was paying an average Management Expense Ratio (MER) of 2.49%. Despite advocating for the behavioural advantages of mutual funds in general, when the costs get this high, one has to wonder about alternatives.
ETFs are a Very Good Alternative, but…
I like Exchange-Traded Funds (ETFs). If for no other reason, they offer the advantage of much lower costs, especially if the mandate of the fund in question is simply to track a broad market index. However, as I mentioned in my previous post, they introduce a few requirements that can lead people to behave against their best interests.
All-in-One Asset Allocation ETFs are a Partial Solution
I think these ETFs are a great solution for many investors. They remove one of the behavioural issues that I am concerned about, the gradual drift away from your asset allocation. In that sense, they are just like a balanced mutual fund. You buy a single product, and it is at the fund management level that the allocation between bonds and equities is adjusted to bring your account back to its target balance. Unlike with mutual funds, though, if you are making regular contributions or there is cash left over after a distribution (dividend) payment, ETFs require you to take action to purchase additional units (shares). From personal experience, I know how difficult it can be to buy into a declining stock market. If the purchase is automated, though, that problem is resolved.
Enter the Robo Advisor
If you want the automation available through mutual funds, but you don’t want the price often associated with such funds, the so-called Robo Advisor may be close to the perfect solution.
If you are a bit on the older end of the age spectrum, you may remember a robot that fascinated me as a child: the robot from the TV series Lost in Space (see above). A couple of years ago, Lost in Space was revived on Netflix. Unfortunately, that Robot lacked the charm of the version from a half-century earlier. I digress.
Although Robo Advisor has become the standard term to refer to this particular segment of the investment management market, a better term might be online or digital portfolio manager. A portfolio manager or portfolio management firm, unlike most mutual funds representatives, is held to a fiduciary standard. They must “act with care, honesty and good faith, always in the best interest of their clients.” This is not to suggest that mutual funds representatives do not care for their clients, but the regulatory standards have not historically called for that duty of care.
The impact of this is that the person who invests through a Robo Advisor has a portfolio management firm that is obligated to act in your best interest. Go to the Portfolio Management Association of Canada website and among the firms listed you will find Robo Advisors like Justwealth Financial, Nest Wealth Asset Management, and WealthBar Financial Services (now known as CI Direct Investing). There are several other Robo Advisors, too. You can find a list, courtesy of MoneySense, here.
Let me revisit my list of praiseworthy characteristics of mutual funds from my previous blog post and see how they might apply to a Robo Advisor.
Ease of Purchase, No Intra-Day Trading, Systematic Investment Plans
Robo Advisors work online. Paperwork is digital. Part of that process involves completing a series of questions to determine the account types and asset mix of your investments. You may even work with a personal portfolio manager who will review the asset mix with you to make sure it is appropriate. After that, it is a matter of arranging to transfer money into your account, which the Robo Advisor will manage on a discretionary basis. There is no need for you to “pull the trigger” and make the investment decision. Issues of intra-day trading and of making the decision of when or whether to invest are out of your hands.
Diversification
Most Robo Advisors use a mix of broad-based index-tracking Exchange-Traded Funds (ETFs). However, some firms also use more narrowly focused ETFs or even somewhat unconventional assets like private equity or mortgages. Those particulars are something that every investor should investigate, but the point to make here is that the portfolios offered by Robo Advisors are broadly diversified.
Commission and Fees
There is variety here. Some charge a monthly fee below a certain threshold, while others waive any fees until a certain level is reached. Others charge a flat dollar amount. Yet others charge a fee based on the value of the assets under management (AUM). Some charge an additional commission for each transaction while others include any trading expenses within their AUM fee. In other words, there is a wide variety.
A good source for an overview of the fees charged, including the MERs of the ETFs that make up the portfolio, can be found in an article by Globe and Mail columnist Rob Carrick, “Robo-advisers laid bare – how they compare on fees, returns and investing approach.” Depending on the account balance, the fee will differ, but using Carrick’s example of the fees for a $50,000 portfolio as an example, the average fee across nine different Robo Advisors works out to 0.71%, considerably lower than a portfolio of D-Series mutual funds that a DIY investor might use. Remember, for that 0.71% you get a professionally managed portfolio so it might be better to compare the fees associated with a Robo Advisor to a mutual fund portfolio provided by an investment advisor, where the overall fee might be greater than 2%. If your investment advisor does financial planning, too, then that extra fee could well be worth it, but the relatively low fee of the Robo Advisor does make for a compelling alternative.
Your overall costs can be significantly lower if you choose the DIY route and use ETFs (or TD’s e-Series index mutual funds), limit commissions by trading infrequently or holding your accounts at a commission-free broker, but you have to be willing to address the full range of DIY issues that arise.
Closing Observations
Robo Advisors address a lot of issues that come up when investing these days:
- They are low cost;
- They are simple to set up;
- They provide for broadly diversified investment portfolios, which manages risks; and
- They take the investment decisions out of your hands and put them into the hands of a fiduciary. They therefore solve the behavioural issues investors often face.
A List of Robo Advisors
Finally, if you want to explore your options, in addition to reading the MoneySense and Globe and Mail articles mentioned above, click on these links to check out the value these Robo Advisors may have for you.
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Disclaimer: This blog post is intended for general information and discussion purposes only. It should not be relied upon for investment, insurance, tax, or legal decisions.