Every investor who has fired a bad adviser and become a do-it-yourself-er has probably had mixed feelings. On one hand, it’s liberating to get away from a costly strategy that was performing poorly. But if you’ve never managed your own portfolio, it won’t take long to realize it’s not as simple as you first thought. In the last couple of years a growing number of U.S. investors has been bridging that gap with online services that design, implement and manage ETF portfolios for a fraction of the cost of a human adviser.
These so-called “robo-advisers” take you through a series of questions to determine your goals and your risk tolerance and then build a diversified portfolio using an appropriate mix of equity and bond ETFs. The service looks after rebalancing and reinvestment of dividends: all you do is contribute regularly and the software does the rest. Wealthfront, which bills itself as “the largest and fastest growing software-based financial adviser,” even includes tax-loss harvesting for accounts over $100,000.
The cost for all of this? At Wealthfront you can invest your first $10,000 for free, after which the fee is 0.25% annually. Its largest competitor, Betterment, charges 0.35% on balances under $10,000, 0.25% between $10,000 and $100,000, and 0.15% thereafter. This includes all transaction costs, but not the management fees on the underlying ETFs, which add another 0.15% or so to the price tag.
For the right investor, it’s difficult to imagine a better solution. A good adviser can add a lot of value with large portfolios (especially in taxable accounts), as well as those who need planning services. But there’s a huge number of families with five-figure RRSPs who don’t need the services of an adviser—and they aren’t getting attention from their adviser even if they have one. Many are paying 2% or more for rotten portfolios and nonexistent service. While it’s easy to tell them to become DIYers, the truth is most are not capable of effectively managing an ETF portfolio on their own. A software-based solution could cut their fees by 75% and deliver better results with minimal effort.
Even savvier investors would benefit from services like Wealthfront and Betterment: sure, they could save 0.25% or so by building and maintaining their own ETF portfolio, but there is a huge behavioral advantage to automating your investment plan. Although making regular monthly deposits and periodically rebalancing a portfolio sounds simple, most people are temperamentally incapable of doing so. (There is ample evidence to demonstrate this, and my e-mail inbox would corroborate it.) I’d estimate the discipline imposed by a robo-adviser would easily add 0.25% to what most DIYers would get using the exact same portfolio.
Unfortunately, there’s nothing like Wealthfront or Betterment in Canada. Will we ever see something similar in this country?
A daunting challenge
I’ve spent a lot of time thinking about the robo-adviser model and discussing it with colleagues. As much as I love the idea, it’s hard to see how it could ever be a viable business in Canada. Wealthfront launched late in 2011 and recently crossed $500 million in assets. While that’s a lot of money to you and me, when your fee is just 0.25% it works out to gross revenues of $1.25 million annually. Not chump change by any stretch, but it’s not even enough to pay for overhead and salaries.
Yes, it takes time for any start-up to turn a profit, and Wealthfront claims 450% growth in 2013, so it’s very possible the business will become lucrative in the future. But the robo-adviser business has extremely low margins and can only survive by building enormous scale. In a country with a population 10 times smaller than the U.S., how can an online financial adviser ever do that?
My guess is the vast majority of robo-adviser clients have four- and five-figure portfolios. If these investors are paying 0.25%, their fees aren’t even covering the cost of the paperwork. The most profitable way to build scale in the investment management business is to go after high-net-worth clients. But investors with large portfolios aren’t likely to be attracted to generic software-based solutions: they’re much more likely to recognize the value of paying a professional for good advice tailored to their individual needs. They also have access to the best advisers and the lowest fees already.
There is one advantage robo-advisers would have in Canada: fewer good alternatives. American investors with as little as $1,000 can already go to Vanguard and buy a target retirement fund for 0.16% to 0.18% annually. So Wealthfront and Betterment will have to wrest assets away from a juggernaut with even lower costs. In Canada, robo-advisers would face far less worthy competition and might be able to grab a bigger share of the DIY investor market.
Unfortunately, I have to conclude that software-based portfolio management isn’t likely to become a reality in this country. But I sincerely hope there’s an entrepreneur out there who will prove me wrong.