Since my article “What Exactly Do Online Investment Services Offer?” was published in the January 2015 AAII Journal, the robo advisory industry has evolved.

There are now more robo advisory services, and some very big investment firms have entered into the space. As such, an update is warranted.

Much of the enticement of these online advisory services comes from the desire to remove human emotion from investment decisions. Computers do not fall in love with stocks, but people do. Other enticements include lower costs compared to traditional advisers and time savings by allowing a computer to choose, reallocate and rebalance investments.

While robo-advisers are a hot topic, they control only a small portion of assets compared to traditional advisers. Assets under management (AUM) for the robo services interviewed for this article (displayed in Table 1) total roughly $63 billion. Over half of that amount can be attributed to Vanguard’s robo advisory service, Vanguard Personal Advisor. Although not all the robo services currently in existence are included in the $63 billion calculation, robo services manage a very small sum of investor dollars relative to the $16 trillion managed by mutual funds.

You may notice the word “generally” used throughout this article. This is because every robo-adviser is different in their approach, methodology, asset allocation, etc. The analysis and observations in this article are based on information from the respective companies’ websites and derived from questionnaires sent to each robo-adviser.

Companies were excluded from Table 1 if they did not respond to our questionnaire. Despite several inquiries, the companies that did not respond include Fidelity and Folio Investing. Motif Investing and Wealthfront initially responded, but didn’t follow up or complete the questionnaire prior to the printing of this article. Appian Road, Capital One, Edelman Financial Services, FutureAdvisor, Huygens Capital and Worth Financial Management declined to participate.

Robo Advisory Industry

When robo advisory services were first offered, both investors and reporters questioned traditional advisers on their thoughts. Many described robo-advisers as a “market disruption”— something the traditional advisers should fear. However, that tone has changed. Instead of worrying about a robo revolution, many large traditional advisory firms are choosing to work with the robo-advisers via acquisitions and partnerships, while others are taking it a step further by launching their own robo service.

Among the acquisitions made in the past two years are:

• Ally Financial acquired TradeKing Advisors;
• BlackRock acquired FutureAdvisor;
• Fidelity acquired E-money;
• Goldman Sachs acquired Honest Dollar;
• Interactive Brokers Group acquired Covestor;
• Invesco acquired JemStep;
• Northwestern Mutual acquired Learnvest; and
• United Capital acquired FlexScore.
• Among the most notable launches in the past two years are:
• Alpha Architect launched Alpha Architect Advisor;
• BMO Harris Bank launched SmartFolio;
• Charles Schwab started Schwab Intelligent Portfolios;
• E-Trade launched Adaptive Portfolio;
• Fidelity started Fidelity Go; and
• Vanguard started Vanguard Personal Advisor.

In addition, Wells Fargo and U.S. Bancorp have both announced plans to launch their own robo advisory services.

Large brokerages and investment management firms are finding that robo-advisers and their tools are useful to the traditional financial adviser model. Although traditional advisers were already using complex financial models and systems, robo technology is helping them automate their practices and better engage with clients online.

There has also been input from the Securities and Exchange Commission (SEC) and the Financial Industry Regulatory Authority (FINRA) regarding robo-advisers and their services. The regulators issued an “investor alert” in May 2015, warning that while “automated investment tools may offer clear benefits—including low cost, ease of use and broad access—it is important to understand their risk and limitations before using them.” They listed five guidelines for investors considering a robo-adviser:

1. Understand any terms and conditions.
2. Consider the tool’s limitations, including any key assumptions.
3. Recognize that the automated tool’s output directly depends on what information it seeks from you and what information you provide.
4. Be aware that an automated tool’s output may not be right for your financial needs or goals.
5. Safeguard your personal information.

The Department of Labor (DOL) ruled in April 2016 that the fiduciary standard would be extended to apply to advisers who provide advice on retirement plans, adding another layer of complexity. The fiduciary standard requires brokers to put their clients’ best interests before their own. Traditional brokers will be held to this standard in regard to retirement accounts. There is much debate as to whether robo services can live up to the fiduciary standard. We discuss some of the arguments in the article “Possible Pitfalls of Robo-Advisers” in the September 2016 issue of Computerized Investing.

Robo Services: An Overview

What do robo-advisers do? Generally speaking, they are online investment management companies that generate “custom” asset allocations, place trades, invest in a tax-efficient manner and automatically rebalance an investor’s portfolio. This said, each robo-adviser has a different value proposition for their clients.

Furthermore, some services don’t customize the asset allocation for each investor, but instead categorize an investor based on responses to a set of 10 or so questions, then allocate his or her portfolio based on their age, investment goals and risk tolerance.

Most robo-advisers invest primarily in exchange-traded funds (ETFs); however, as shown in Table 1, many of them now offer other securities as well.

Table 1. Robo Advisory Services
Download the excel version of this table here.

Many of the robo-advisers use “goal-based investing;” allowing the investor to choose from a generalized list of goals such as preparing for retirement, saving for a major purchase or building wealth. The investor’s next option is choosing whether they are investing for the short, medium or long term and how much they want to deposit. Betterment, Schwab Intelligent Portfolios and Vanguard Personal Advisor specifically refer to following a “goals-based model.”

In order to determine a person’s risk tolerance, some services will ask questions such as “if the market dropped 15% in one day, what would you do?” The response options are usually a version of: sell everything, reallocate my investments or purchase more. Some services ask an investor to assess his or her risk tolerance on a scale from very low to very high.

Based on a person’s age, goals and risk tolerance, the robo-adviser generates a recommended asset allocation. In most cases, the asset allocation models change depending on whether the investor is opening a retirement account or a taxable account. Tax-efficient investments are placed in the taxable account, and less tax-efficient investments go in the retirement account. Robo-advisers roughly determine tax efficiency by the cash flow distributed by an investment: The higher the cash flow (dividend and interest payments), the less tax-efficient the security. Alpha Architect, AssetBuilder, Betterment, Personal Capital, Schwab, Vanguard and WiseBanyan all mentioned “tax-efficient investing.”

Of the companies responding to our questionnaire, Betterment, Personal Capital, Schwab Intelligent Portfolios, Vanguard and WiseBanyan said that they offer tax guidance. Each of these services made it clear that they are not tax professionals and offer only a “high level” of tax guidance. Of the companies researched, Betterment discussed tax efficiency the most. Aside from tax-efficient investing and tax-loss harvesting, Betterment offers other tax-related tools such as TaxMin Lot Selling, which chooses which specific lots are most tax-efficient to sell, and Tax Impact Preview, which estimates the taxes potentially owed before an investor’s allocation is changed.

Vanguard Personal Advisor appeared to be the most comprehensive and “hands-on” of the robo services. The service requires its clients to speak with a human adviser. It also charges for the creation of an investor’s financial plan, which can range from free to $1,000, depending on how much you invest.

Alpha Architect, AssetBuilder, Betterment, Covestor, Personal Capital, Rebalance IRA, Schwab Intelligent Portfolios and Vanguard Personal Advisor all offer clients guidance on retirement withdrawals. However, be sure to ask a prospective service exactly what it offers before expecting to receive specific guidance on withdrawals or investing in retirement.

Several of the robos interviewed specifically mentioned a tax-loss harvesting feature, including Betterment, Hedgeable, Personal Capital (with over $25,000 invested), Schwab Intelligent Portfolios (with over $50,000 invested) and WiseBanyan. Tax-loss harvesting is the practice of selling a security that has fallen in price in order to “harvest” a loss and subsequently offset taxes on both gains and income. The sold security is replaced by a similar one, which allows the investor to maintain the asset allocation. Schwab Intelligent Portfolios actually displayed the funds they “switch” between for tax-loss harvesting purposes.

Both Personal Capital and Vanguard Personal Advisor stated that they can provide “high-level” guidance on more complex topics. Vanguard’s range of services include help on estate planning, charitable giving, Roth IRA conversions and trust services, while Personal Capital offers help on insurance planning, 529 plans, home purchasing and refinancing, stock options, deferred compensation and estate planning.

While other firms may offer account aggregation, only Betterment, Hedgeable, Personal Capital and Vanguard specifically mentioned that an investor can link to other investment accounts on their platforms.

Based on the information we collected, Alpha Architect, AssetBuilder, Betterment, Hedgeable, Personal Capital, Schwab Intelligent Portfolios, Vanguard Personal Advisor and WiseBanyan allow clients to set up recurring deposits. Betterment also recommends deposit amounts for investors based on their stated goals.

Macroaxis and MarketRiders don’t manage money for their clients. Instead, they help investors optimize their portfolios and recommend rebalancing that the investor can do within his or her own brokerage account. Another company that operates in this space is MyPlanIQ, which was described in the May 2016 issue of Computerized Investing.

Asset Allocation Recommendations

Of the robo services that provided information to us, a handful allow prospective clients to go through a questionnaire before signing up to receive an asset allocation recommendation. They include Alpha Architect, AssetBuilder, Betterment, Hedgeable, Schwab Intelligent Portfolios and TradeKing Advisors. Investors who have a retirement or brokerage account directly with Vanguard can take the Vanguard Personal Advisor questionnaire; however, an allocation is not provided without first speaking to an adviser.

To compare the allocation recommendations, we completed client questionnaires using the profile of an “average” AAII member: age 65, preparing for retirement, slightly risk-adverse but willing to take on some volatility, and investing for the medium to long term. An initial investment of $50,000 was used, which represents a fraction of the average AAII member’s portfolio. Both a taxable and retirement account were selected where applicable to see how the allocations changed based on account type.

Every service’s questionnaire was different, so it was not possible to enter the exact same profile using our “average” AAII member description. However, all of the robos categorized this hypothetical investor in the medium to medium-high risk category for both taxable and retirement accounts.

Generally speaking, most of the companies excluded real estate investments and corporate bonds from taxable accounts for our hypothetical investor. An exception was Schwab Intelligent Portfolios, which included U.S. real estate investment trusts (REITs), international REITs and U.S. corporate high-yield bonds in a taxable allocation.

Hedgeable gave our hypothetical investor the highest allocation to U.S. stocks in taxable accounts, at 86.5%. Hedgeable also had the highest retirement account allocation to fixed income, at 48.3%. Alpha Architect and Betterment made no allocation to cash, but Schwab Intelligent Portfolios allocated 8.2% to cash in a taxable account and 8.5% to cash in a retirement account. It’s worth noting that Schwab Intelligent Portfolios states that it will maintain a cash balance of 6% to 30% for every client.

Betterment and Schwab had the most specific breakdowns of allocation (from a prospective client point of view), showing a distinction between large-cap and small-cap stocks, U.S. and international REITs, U.S. bonds, U.S. high-yield corporate bonds and U.S. investment-grade bonds. In comparison, most other firms generally grouped these into the broad categories of domestic stocks, domestic bonds and real estate.

TradeKing Advisors didn’t allocate any funds to currencies, gold and precious metals or commodities, whereas Hedgeable included a 2% allocation to currencies in the taxable account and 6% to master limited partnerships (MLPs) in the retirement account recommendations for our hypothetical investor. Schwab allocated 5% to gold and precious metals in the retirement account, and nearly 6% in the taxable account. Betterment’s allocation did not include commodities, currencies or precious metals, while Alpha Architect recommended a 20% allocation to commodities.

Alpha Architect, AssetBuilder and Betterment specifically mentioned “value” investments: AssetBuilder allocated 25% of the portfolio to value, while Betterment and Alpha Architect allocated 18.8% and 10%, respectively.

AlphaArchitect devoted 20% of the portfolio to momentum stocks, while AssetBuilder allocated 14% of our hypothetical investor’s portfolio to growth stocks.

Alpha Architect, AssetBuilder and TradeKing Advisors didn’t make an allocation distinction between retirement and taxable accounts when filling out a questionnaire without having an account.

Managing Volatility & Rebalancing

Alpha Architect, Hedgeable and TradeKing Advisors were the only robo-advisers that mentioned any sort of downside protection or volatility-specific tool. These downside protection systems seek to minimize drawdowns from an investor’s portfolio. They monitor trade signals that trigger “exits” from assets to cash and move funds accordingly. Alpha Architect cautions investors that if they choose to use their proprietary downside protection tool and are investing in a taxable account, they may incur a gain or loss in accordance with the strategy.

During the Brexit sell-off in June, Betterment halted trading by clients on its platform. When we asked about the trading halt, the firm responded, “On occasions when the market is impacted by an economic shock, we may delay or temporarily pause trading to avoid the possibility of extreme price dislocation. In the event of this happening, clients still have access to liquidity and can override our recommendation by contacting us.”

While Betterment’s trade halt was controversial at the time, many financial advisers agreed that temporarily suspending the ability to trade can help remove investors’ emotions on a volatile day. Long-term investors should not be overly concerned with day-to-day volatility in the market and can hurt their portfolio by acting irrationally.

When asked about volatility, the other robo services essentially said, “we take a long-term investment approach and don’t participate in the short-term fluctuations of the market.” For many robos, market volatility is generally “managed” by computer systems that decide when it’s time to rebalance. During times of higher market volatility, the portfolios may be rebalanced more often because the market movements are more frequent and significant.

Rebalancing decisions are often made by pre-determined “rebalancing bands” that differ for each robo service. Based on the company’s disclosure, Vanguard’s rebalance band is a 5% change from target allocation and quarterly checks determine if rebalancing is needed. Vanguard noted that the band may change based on the client’s risk tolerance, not due to changes in the market.

Personal Capital was the only company to mention the word “turnover.” The company stated that its goal is to keep turnover below 15% in a given year. Personal Capital considers “high level asset classes” for rebalancing when they deviate “more than a few percentage points from the target.”

Rebalance IRA stated that it rebalances on average two times a year. WiseBanyan says it will rebalance if a portfolio strays 5% from its target allocation. Betterment allows for a 3% portfolio drift (sum of absolute deviations of each asset class divided by 2) before rebalancing, but also mentions that portfolio drift can stay above 3% if there are no long-term lots to sell.

While rebalancing during volatile markets can be advantageous to investors, investors also need to be sure to consider the fees involved with rebalancing. As displayed in Table 2, Alpha Architect, Betterment, Fidelity, Hedgeable, Personal Capital, Schwab Intelligent Portfolios, TradeKing Advisors, Wealthfront and WiseBanyan reported that they do not charge for trades. With these services, frequent rebalancing will not affect the fees you’re charged.

Table 2. Robo-Adviser Fees

However, frequent rebalancing can affect your returns over time in other ways. Too much rebalancing can affect the momentum of your portfolio’s return. Additionally, as William Bernstein noted in the September AAII Journal (“Investing to Avoid the Consequences of Being Wrong”), having a one-size-fits-all rebalance band can be less effective because one asset class can be more or less volatile than another. Bernstein believes that each asset class should have its own rebalancing band.

Rebalancing too often can also affect your returns via taxes by incurring more short-term gains, which are taxed at a higher rate than long-term gains.

The Costs of Using a Robo-Adviser

Table 3 compares the management fee range for the robo services to that of traditional advisers for different account sizes. Schwab Intelligent Portfolios and WiseBanyan both charge no management fee irrespective of the amount of assets managed. In the case of Wealthfront, the first $10,000 is managed for free.

Table 3. Asset Management Fee Ranges

Lower costs compared to traditional advisers has been a strong point in the value proposition for many robo-advising firms.

The Expense Ratio column in Table 2 represents the expense ratios of the underlying instruments used by the robos. An NA is displayed for Covestor because their managers use a wide range of assets as opposed to solely investing in ETFs and mutual funds; it felt that an average expense ratio range was not applicable to its service.

ND in the table stands for “not disclosed”—meaning that specific information could not be found on the robo-adviser’s website.

Personal Capital and Vanguard Personal Advisor have an asterisk by their management fees because both offer lower fees for accounts that reach well over a couple million dollars.

On a relative basis, based solely on management fees, robo-advisers offer a lower-cost alternative to traditional advisers. The key is what services are offered for the respective fee. If a traditional adviser, in addition to managing money, handles life insurance needs, health savings accounts and college savings as well as assists with estate planning and offers extensive retirement and tax planning help, the higher fee may be justified. Such services are not generally offered by robo-advisers.

Comparing Performance

A major question many investors ask is, “How does the performance of the robo-advisers compare to that of traditional advisers?” This is not a question that is easy to answer.

Most of the robo advisory services that post performance online display backtested or model-based results. Each robo-adviser has different inception dates, and some don’t disclose those dates. Prospective clients have to search for the performance disclosures just to read the fine print. Most of the returns are displayed net of fees and assume reinvestment of dividends and interest.

Although the lack of sound performance figures may seem disheartening, displaying truly representative returns is difficult because many investors have customized portfolios—fees, allocations and rebalancing intervals can all be different on an account-by-account basis. Clients open accounts at different times, so even if the respective risk/reward profile categories don’t change, the starting portfolio value will. Also, many of the robo services haven’t been around long enough to present meaningful longer-term return figures, hence the reporting of backtested results.

Each company stated that they have historical performance figures available; however, there were caveats. In order to see historical performance for Alpha Architect, MarketRiders and Rebalance IRA, you must have an account. Alpha Architect will send historical figures to prospective clients on a case-by-case basis, or refer clients to their book, “DIY Financial Advisor: A Simple Solution to Build and Protect Your Wealth” (Wiley Finance, 2015) where the strategies are defined, explained and analyzed.

Schwab Intelligent Portfolios, Vanguard Personal Advisor and WiseBanyan all state that investors can see performance by looking up historical performance of the funds within each robo strategy the firm offers. However, of the three, Schwab is the only one that actually discloses the particular funds used in a given strategy and their respective weightings.

Of the companies in Table 1 that actually post their performance figures online, only Betterment and Personal Capital publish a benchmark. (I could only find readily accessible performance figures online for Asset Builder, Betterment, Hedgeable, Personal Capital and TradeKing.)

What to Look For

That these investment services are online may be a concern for investors who are not computer-savvy. When we surveyed these companies, it was important that they—at the very least—had some sort of ability to be contacted by the telephone. If an advisory firm is going to manage hundreds of thousands of dollars for individuals, it should be easy to get a hold of.

Here is a quick list of what to look for if you are going to go the online investment service route.

1. Read the “About Us” section

Is this section of the website vague? Some websites give you the bare minimum when it comes to information about what they do or how they manage your money. Make sure that the website has a lot of information.

2. Ask questions

Some of the questions you should ask include:

• What are the basic services I will receive?
• How often is the portfolio reviewed?
• How often is the portfolio rebalanced and do you rebalance on specific time intervals or based a pre-determined rebalancing bands?
• Who is doing the actual investing in the portfolio? Me or the company?
• What is the minimum amount required to invest?
• What kinds of fees can I anticipate incurring? (management, expense ratios, commissions)
• What type of communication can I expect? (telephone, email, etc.)
• What types of securities will you be investing in or recommending?
• Is tax guidance provided?
• Is guidance on taking retirement withdrawals given?
• What are the advisers’ licenses?
• What if I don’t like a particular recommendation or asset class? Can you adjust it?

3. Read the FAQ section

Look through popular questions that many other investors had have. This section typically proves to be very insightful.

4. Download and read the company’s disclosure agreement

There are often caveats hidden in the fine print. The disclosure agreements are easy to read, and definitely worthy of analysis.

5. Think about what services you actually need and see if they offer them. Do not make exceptions.

If you need tax guidance and the advisory firm doesn’t provide it, don’t go that route. If you are more concerned about risk management, but the adviser doesn’t look at your risk tolerance when deciding asset allocation, run away.

6. Make sure you have constant access to your account information and monitor all the transactions.

Some of the companies we spoke with didn’t specify how often they send investors updates on their portfolio. You want these updates. If they are making moves with your money and you’re not aware of what is going on, that’s bad news.

Who Should Use Them?

Robo-adviser services are likely a better choice for investors with less complex financial situations. They may be a good choice for an investor looking to “set it and forget it,” who wants a basic diversified portfolio and is less interested in personally managing his or her money.

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