Robo-advisors: Are they really the best choice for young investors?

M A K I N G B A N K

My foray into investing has been enlightening so far. I’ve been frozen with fear about making mistakes (even with fake money), I made a few trades and watched the value of equities rise and fall.

I’ve learned that Questrade is pretty complicated to use, especially if you’re new to investing. And now, I wonder if my investing needs are better handled by a robot. You’ve no doubt heard of robo-advisors, (if you haven’t then you really need to visit MoneySense more often). For those who don’t know what a robo-advisor is, a robo-advisor is a service with which you can open an online account, that often assesses your risk profile, your financial goals, then recommends an ETF portfolio crafted by super-geniuses (so I assume) that you can stick money into. The robo-advisor then takes care of your investments and keep your asset allocation from falling out of whack. Think couch potato portfolio, but with an extra plush pillow, a cozy blanket and a minion delivering you goodies as you binge-watch Netflix. In short, it’s pretty hands-off. You don’t have to make trades yourself or fiddle around with your portfolio.

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Even if you’re oblivious to the goings-on of the financial industry, you’ve probably still heard of Wealthsimple. Or at least seen their one amazing Superbowl ad that probably punches your anxiety right in the gut. Yeah, that’s the one. I’ve been intrigued by Wealthsimple for a while now and decided to take their introductory assessment (which you can also do right here). Let’s say my goals for the sake of the assessment are buying a home at 30, and having to tap my nest egg—for, uh, something—at age 35. The plan it spat out encouraged me to save around $800 a month between my home-buying goal and my retirement nest egg (it’s high but doable if you’re willing to set a realistic goal for yourself). Those funds are split 50/50 asset allocation in fixed income and equities, spread out between nine ETFs. With a Wealthsimple account, there is no fee on the first $5,000 is invested with the robo-advisor for the first year (though you will still have to pay management fees for the individual ETFs of around 0.2% each depending on the fund). Any money invested above that amount is subject to a fee of 0.5% of the value of your assets. It recommended how much I should save each month and provided outlooks for my earning potential over the timelines I chose (age 30 and 35).

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Once you’ve signed up, your automated contributions are underway and the service rebalances for you so you can really set it and forget it for a little while. If you want to talk to somebody to get a bit of guidance, you can be put in touch with a portfolio manager for “on-demand financial advice.”

How this compares to self-directed investing

Self-directed investing is a lot more…involved, let’s just say. If you’re new to investing but you’re really interested in having complete control over what you invest in and when, it’s definitely worth your time (although you’ll need a lot of it). It takes significantly more work versus either a robo-advisor or trusting your funds with an advisor at one of the large banks. It’s also more expensive. For the most part you cannot set up an automatic contribution savings plan with ETFs because you’d have to pay a transaction fee of something like $10 on each buy and sell. That adds up fast, especially when you’re only managing a small pool of money. Consider the following: Let’s say you’re saving $50 a week and putting it into ETFs. Then $10 (or 20% of your $50 investment) would be lost to fees if you tried to invest the money as you put it into your account. You don’t need to be good at math to know that’s a raw deal. Instead, if you’re like most small DIY investors, you’d likely hold off investing the money until you had enough saved up to make the fee worthwhile, but that means you’re wasting time during which your money could be invested and growing. When you’re managing your own ETFs you also have to keep an eye on your portfolio to rebalance when your asset allocation gets out of whack. What does that mean? Well, as the markets move, the percentage of your portfolio that is invested in stocks versus, say, bonds, moves too as the equities gain and lose value. So you might start off having 50% of your portfolio in risky stocks and 50% in safe bonds, but over a few months that could move to 60% stocks and 40% bonds. If you are not paying attention you’re exposing your hard earned dollars to risk you weren’t prepared to take on. If you are paying attention, you need to rebalance every few months, meaning you have to go into your account and sell and buy equities to make everything right again. That means more transaction fees and time. To a lot of people, this is minimal commitment for a successful portfolio. To others, it’s complete drudgery. It’s up to you, really. (By the way, you could also go for a cheap Tangerine balanced fund for a simple, cost effective, self-directed approach.)

What if you stuck with your bank?

I’m going to guess that for a lot of people my age, this is the stage you’re at right now. You have a TFSA or some investments with your bank. Or a TFSA and no investments. Either way, since you’ve been with the institution your whole life, you likely trust your bank. Having your investments handled by an in-house financial advisor can be pretty hands-off too, if you want it to be. But you almost certainly won’t be in ETFs with a big bank as they usually favour mutual funds. And that means you’re paying a whole lot more in fees than you would be if you were with Wealthsimple or another discount brokerage, investing your own money. The fees baked into your mutual fund costs can add up to nearly 2.5%! That’s a lot more than 0.5-0.7% with Wealthsimple or a self-directed account. Paying those fees hits your total return so if you’re in mutual funds you’d have to be prepared for your money to grow a lot less than if you went with ETFs. That’s the cost of being lazy and staying with a Big 5 bank! Fee comparison on $10,000 with a portfolio of 9 ETFs in the second year of investing:

Robo-advisors vs DIY portfolio

For argument sake let’s say I wanted to build the exact same portfolio as the one recommended to me by Wealthsimple. Here’s how those costs break down if I was to set up this account today and rebalance my portfolio at least once during the year:

	Wealthsimple	Discount brokerage
Amount invested	$10,000	$10,000
Fees	0.5% annual service fee	Typically $9.95 per trade
Cost	$50/year*	up to $300/year (rebalancing once, selling a portion from most of the ETF in the portfolio and reinvesting the proceeds)

* For this illustration we’ll ignore the fee promotion on the first $5,000 Now here’s how the costs compare to a mutual fund portfolio offered to you by a bank on that same portfolio. Because the MERs in the example above were the same I didn’t need to factor that into my comparison, but because the MERs are different between the ETFs used by Wealthsimple and bank mutual funds, we have to factor them in here.

	Wealthsimple	Bank mutual funds
Amount invested	$10,000	$10,000
MER	0.2%	2.5%
Fee costs	$20	$250
Maintenance costs	$50/year	$0
Total cost	$70	$250