Robo-advisors are a relatively new way to manage your investments. They are on-line portfolio managers, who ask you a few questions to assess your risk tolerance, and then build your portfolio from a stable of ETFs. Some robo-advisors use very large and reputable ETF companies, such as Vanguard and iShares, both of which are very good.
Once you answer your profile questions and open an account, you deposit your money and then the robo-advisor buys and sells ETFs on your behalf. Most robo-advisors allow you to ask any questions online or by phone that are answered by qualified human advisors.
There are a few things to watch out for with respect to robo-advisors:
The minimum investment required is typically about $5,000. For investments of $5,000 or less, or if there is no stated minimum, the fees for small investment amounts are horrendous, i.e., between 2.5% to more than 5%, plus ETF fees.
When you answer the online risk questionnaire, some robo-advisors ask leading questions that stimulate you to answer "yes." This "yes" means the robo-advisor will stick you in a high-cost ETF that may not really be in your best interest.
Typically, once your portfolio is determined (by you answering profile questions), you can't make any changes to the ETFs that are auto-selected for you. This is not great, as some of the questions they asked you to answer in order to set your risk profile are unclear or misleading.
Some robo-advisors are using ETFs with a very short trading history, i.e., a limited track record of performance, and very low market capitalizations (i.e., they are very small funds).
Robo-advisors fill the gap between "do-it-yourselfers" who open their own self-directed brokerage accounts, but need to spend time and effort acquiring knowledge on what to buy and sell, and conventional full-service advisors who may provide lots of advice, but who can charge total fees in excess of 2% and even up to 3%.
There are two fees you will pay when investing with a robo-advisor. First is the fee paid to the robo-advisor itself, and the second is the fee paid to the ETF company.
To the Robo-advisor company:
If you have less than $5,000 to invest, some robo-advisors will not accept you as a client, and as previously mentioned others will charge you horrendous fees. Based on the robo-advisors sites I have reviewed, Wealthsimple is one of the best robo-advisors if you are starting with less than $5,000. If you have between $5,000 to $150,000, robo-advisor fees will typically range between 0.5% to 0.7%. If you have between $150,000 to $500,000, robo-advisor fees are about 0.5%. If you have more than $500,000, robo-advisor fees will typically range between 0.35% to 0.4%.
To the ETF company:
The ETF fees you pay are in addition to the robo-advisor fees. ETF fees can range from a very low .05% for the largest ETFs with long track records, to 0.80% for smaller, more niche ETFs. On average, depending on the mix of ETFs the robo-advisor put you in, robo-advisors say your average ETF fee will be between 0.2% and 0.35%.
Combined Fee for Both:
If you have between $5,000 to $150,000 to invest, expect to pay total fees of 0.7% to 1.00%.
If you have between $155,000 to $500,000, expect to pay total fees of 0.7% to .85%.
If you have > $500,000, expect to pay total fees of 0.6% to 0.75%.
Robo-advisors are a good idea, and superior to most conventional high fee advisor offerings.
TheAnswerIs is closer to the robo-advisor model than a conventional financial advisor.
TheAnswerIs provides more online investing knowledge than most robo-advisors. Most robo-advisors have a staff of qualified advisors who can be contacted online or by phone. TheAnswerIs offers information for long-term investing, which may or may not be appropriate for your situation.
TheAnswerIs provides the knowledge, and hopefully teaches you to have the aptitude you need to become a successful investor, in exchange for only a charitable donation. Importantly, with TheAnswerIs, you keep control of your money as it remains in your own investment accounts. Also, you retain the flexibility to select the investments that are put into your investment account.
Robo-advisor fees, plus the higher-cost fees for the ETFs a robo-advisor recommends, will have a significantly negative impact on your long-term returns. TheAnswerIs suggested charitable donation amount equals only half of most robo-advisor fees and TheAnswerIs focuses on the largest and lowest-cost ETFs available, saving you additional fees.
And finally, since TheAnswerIs raises money for charity, you get a tax receipt for 100% of the amount you donate.
Let's look at the impact of fees on a one-time investment of $5,000 invested at 10% per year for 40 years, (it sounds like a long time, but remember life expectancy is now 85+- years!).
First, with no fees, a one-time investment of $5,000 earning 10% per year for 40 years will net you a remarkable $226,296. That's right, your Current Self invests $5,000 once, and your Future Self will have $226,296!
Now, if you use a conventional advisor, who charges you only 2% per year, your Future Self will only have $108,623, That is $117,673 less! More than half your return will be gone!!
Now, let's say you took the robo-advisor route and paid an average fee of .7%. Your Current Self's $5,000 investment will now only grow to $175,298. Your Future Self will have $50,998 less, or about 20% less!
Yes, learning about investing takes a little time, but as you can see, you will be well paid to learn how to invest for yourself.
TheAnswerIs empowers you, but if you don’t want to take the time, the next best thing for you to use is a robo-advisor, and the one of the better ones we have identified is Wealthsimple.