Are Robo Advisors Worth Their Fees?

June 10, 2019 | Investing, ETFs, Robo Advisors

Are Robo Advisors Worth Their Fees?

The earliest Robo Advisors appeared in Canada around 2014. 

When they first came on the scene, I thought they were brilliant - and for the most part, I still do.

Robo Advisors are an anecdote to the highly conflicted, high cost advice provided to the masses by the banks, mutual fund dealers and insurance salespeople.

Most importantly, Robo Advisors fill the so called ‘Advice Gap’.  Servicing people who aren’t up to handling their own investments as DIYers and don’t have enough savings to qualify for professional financial advice - but in need of a one stop, low cost and reliable investment solution.

As true disrupters to an entrenched industry, they are a great solution for smaller investors who don't need financial planning advice - but Robo Advisors are now being challenged by potentially superior alternatives with dramatically lower fees.

So…what is a Robo Advisor?

It’s important to know that they’re not staffed by robots – not even close.

The core widget that all the Robo Advisors share is that they are powered by automation – financial technology – Fin Tech for short.  Everything about these platforms is intended to provide a quick and streamlined user experience. 

Signing up and opening an account is generally quick and easy – a fully automated guided experience, complete with digital signatures for fast account opening.

An important part of the account opening process is the questionnaire used to determine your investment objectives, risk tolerance and investment time horizon.  This information is used to determine they type of portfolio that is best suited to your investment objectives and risk tolerance. 

The benefits of Robo Advisors haven’t changed much over the years.

They’re low cost.  Low fees have always been the primary competitive advantage (over traditional Advisors and Mutual Funds) most Robo Advisors have leaned on.  Depending on the firm Robo Advisors charge somewhere between 0.40% to 0.60% of the total value of your portfolio annually - some firms such as Nest Wealth charge a flat monthly fee.  In addition to this annual fee there are Management Fees (MERs) on the Exchange Traded Funds used to construct portfolios.  These fees can add an additional 0.13% to 0.30% in fees every year.  All in you can expect your costs to be 0.50% to 0.80% per year on your portfolio.

Portfolios are automatically rebalanced.  When a holding in your portfolio does well a portion is sold and reallocated to bring the holdings back in line with prescribed targets.  No action is required by you the client.

They rely on a superior investment philosophy. Robo Advisors typically use Exchange Traded Funds to construct portfolios.  Exchange Traded Funds are passive investment products. A lot of academic research and empirical evidence suggests that passive investors have better long-term outcomes than active investors (stock pickers).

Low Minimum Initial Investment.  Several Robo firms have no minimum investment.  You can start investing with just $1.00.  In other instances, initial investments might be just $1000.00.

Sounds Great….Sign Me Up!

Not so Fast….

When Robo Advisors first appeared, they were offering a service that didn’t exist in terms of cost and convenience.  And they still provide a level of service to small investors which is really valuable – but they aren’t without competition.

Fees Matter…A lot.

The primary widget that Robo Advisors lean on is their low-cost fee structure. Investment Management fees are poison to you long terms returns.  

The math isn’t encouraging – a portfolio with an average annual return of 6% and an annual management fee of just 2% will lose more than half it’s total gains to fees over a 25 year period.

Under the same scenario, consider the impact of the total fees charged by a Robo Advisor. 

With an estimated all in average annual fee of 0.65% - Robo Advisors will take almost 20% of your total gains over 25 years. On a $100,000.00 portfoio this is over $60,000.00 in fees!  Suddenly Robo Advisors don't seem so 'cheap'...

For a service offering basic investment management services Robo Advisors still take a meaningful bite out of your long-term returns.  Especially when you consider that you aren’t getting the value add of rigorous and ongoing financial, estate and tax planning that a traditional professional advisor might offer.  While some Robo Advisors are beginning to offer basic financial planning services they are unlikely to ever match the depth and the personalized level of service offered by a full-service financial planning professional.

Are There Any Alternatives To Robo Advisors?

Until recently Robo Advisors were unchallenged in what they offered Canadian consumers – an inexpensive, accessible and technology driven alternative to high cost, actively managed mutual funds.

For consumers seeking an alternative investment solution the primary attraction to Robo Advisors is their low cost – or at least it should be.

In 2018 two companies Vanguard and BlackRock launched investment solutions which in many ways provide investors with what is arguably a superior investment alternative to what the Robos offer.

Who are Vanguard and BlackRock?

Both these companies are ‘manufacturers’ of Exchange Traded Funds.  Robo Advisors use ETFs to build portfolios for client portfolios - most Robo Advisors use at least some of BlackRock and Vanguards ETFs. 

Both companies have a long history offering index-based investment solutions.

Vanguard was founded by industry icon and visionary Jack Bogle who in 1975 launched the trailblazing “First Index Investment Trust” - a low cost mutual fund which tracked the S&P500 Index in the US – this was one of the earliest index tracking investments. 

Blackrock, came to the ETF game much later, but they’re the other dominant force in the world of ETFs.  With over 800 ETFs and over $1.3 Trillion under management, along with Vanguard, these two companies dominate the ETF marketplace.

Disruptive ETF Offerings – Beating the Robos at their Own Game.

In late 2018 (BlackRock) and early 2018 (Vanguard) both introduced “All In One” ETF Portfolios. 

The concept is simple. 

Whereas traditional ETFs hold a diversified portfolio of stocks which represent either a market index or sector, the All In One Portfolios hold a diversified portfolio of ETFs representing diversification across asset classes and geographic locations.  These ETFs are regularly rebalanced to keep the portfolios in line with target allocations. 

This is no different than what most Robo Advisors offer.

Where Vanguard and BlackRock are really challenging the Robo Advisors are in their fee structure.

Vanguard’s All In One Portfolios come with an annual Management fee of just 0.22%. 

BlackRock’s offers even lower fees of 0.18% annually.

Under the same scenario we looked at earlier, a 0.18% Management fee would result in you giving up just 5% of your gains over a 25-year period.  On a $100,000.00 initial investment this represents a loss of less than $18,000 in fees.  Dramatically less than the $60,000.00 in gains you would give up at a Robo Advisor.

So, yes…if fees are the competitive advantage that Robo Advisors claim, it’s clear they’ve been out manoeuvred by both Vanguard and BlackRock.

What about Commissions When Buying All In One Portfolios?

Commissions are an important consideration when buying individual ETFs (including All In One Portfolios).  Even if you purchase these ETFs through a discount broker you can expect to pay anywhere from $5.00 to $30.00 for each transaction.

But there is a solution.

Several discount brokers allow you to purchase ETFs at no charge and two really outshine the others:

·        Wealthsimple (Yes! The biggest Robo Advisor in Canada!)

·        Questrade (You’ve probably seen their commercials.)

Wealthsimple is particularly interesting.  On their recently launched Wealthsimple Trade platform, they not only allow you to buy and sell ETFs for free, but also stocks on all major North American exchanges - and there's no minimum balance or inactivity fee.

Currently Wealthsimple Trade does not offer purchases in RRSPs and TFSAs. But they promise this will be coming soon. 

Opening a Wealthsimple Trade account and investing in either of the BlackRock or Vanguard All In One Portfolios instead of one of Wealthsimples portfolios will save you an estimated 60% in annual fees.

Questrade is another viable option for buying All In One Portfolios. 

But there are a couple of caveats. 

They only allow you to purchase ETFs commission free – but selling will cost you $4.95. 

There is no minimum balance required to open an account, but if you have less than $5000.00 in your account you'll be charged a quarterly inactivity fee of $24.95.  You can avoid this fee if you either; (a) maintain a balance of at least $5000.00,or; (b) deposit $150.00 into your account every quarter.

Wealthsimple vs. Vanguard: A Quick Comparison

For simple comparison purposes take a quick look into who's behind the investment decisions at the biggest Robo Advisor in Canada (Wealthsimple) and Vanguard.

Vanguard

·        130 Portfolio Review Professionals.

·        28 External Advisors.

·        10,000+ Employees Globally.

·        $4 trillion + in Assets Under Management.

·        Founded in 1975.

Wealthsimple

·        5 person Investment Advisory Committee.

·        200+ Employees.

·        $4.3 Billion+ in Assets Under Management.

·        Founded in 2014.

As a much smaller company with less history, it may seem unreasonable to compare Wealthsimple to Vanguard.  Since they're both trying to achieve the same objective for clients – growing your money using low cost, passive investment strategies – it’s worth know what’s behind the investment and asset allocation decisions being made.  

What’s particularly frustrating about Wealthsimple (at least from my perspective) is that they don’t provide a lot of detail about their process for allocating assets among their various portfolios.  And how they profile their portfolios on their website is extraordinarily vague.

Consider for a moment how Wealthsimple describes their Growth Portfolio

The description reads “our growth portfolios range from 70% – 90% equity”. 

This is confusing.

Growth portfolios? Is there more than one Growth Portfolio? Why is there such a large variance in equity holdings, 70% - 90%?  Does this variance apply to individual portfolios, or ‘the’ Growth Portfolio?

“We’ve modelled an 80% equity portfolio below”. 

Is this a hypothetical portfolio? What do they mean by ‘modelled’? What about the Growth Portfolio?

Vanguard and BlackRock – on the other hand - both offer in depth detail for each of their portfolios which include Fund Fact Sheets, Prospectuses, Summary Documents – and appropriate regulatory disclosures.

The level of detail offered on the Vanguard website on their Growth Portfolio leaves nothing to question. This Link provides a snapshot of each of their All In One Portfolios as seen below, linking to much more detailed descriptions.

 

 % Equity   % Fixed income

Vanguard Conservative Income ETF Portfolio (VCIP)

Investment objective and strategy: Seeks to provide a combination of income and modest long-term capital growth by investing primarily in equity and fixed income securities—either directly or indirectly through investment in seven underlying low-cost Vanguard index ETFs.

  • For investors who are looking for income and moderate long-term growth.
  • Management fee: 0.22%.1
  • Risk rating: Low.

Vanguard Conservative ETF Portfolio (VCNS)

Investment objective and strategy: Seeks to provide a combination of income and moderate long-term capital growth by investing primarily in equity and fixed income securities—either directly or indirectly through investment in seven underlying low-cost Vanguard index ETFs.

  • For investors who are looking for income and moderate long-term growth.
  • Management fee: 0.22%.1
  • Risk rating: Low.

Vanguard Balanced ETF Portfolio (VBAL)

Investment objective and strategy: Seeks to provide long-term capital growth with a moderate level of income by investing primarily in equity and fixed income securities—either directly or indirectly through investment in seven underlying low-cost Vanguard index ETFs.

  • For investors who are looking for long-term growth with a moderate level of income.
  • Management fee: 0.22%.1
  • Risk rating: Low to medium.

Vanguard Growth ETF Portfolio (VGRO)

Investment objective and strategy: Seeks to provide long-term capital growth by investing primarily in equity and fixed income securities—either directly or indirectly through investment in seven underlying low-cost Vanguard index ETFs.

  • For investors who are looking for long-term growth.
  • Management fee: 0.22%.1
  • Risk rating: Low to medium.

Vanguard All-Equity ETF Portfolio (VEQT)

Investment objective and strategy: Seeks to provide long-term capital growth by investing primarily in equity securities—either directly or indirectly through investment in four underlying low-cost Vanguard index ETFs.

  • For investors who are looking for long-term growth.
  • Management fee: 0.22%.1
  • Risk rating: Medium.

 

What’s most appealing about the Vanguard portfolios is that they are very clear about how assets are allocated, portfolios are regularly rebalanced to keep these allocations in line with very specific targets.  Rather than being vague they are detailed, disciplined and intentional. 

Are Robo Advisors Worth Their Fees?

It's important to give credit where it's due.

Robo Advisors have done a lot to introduce low cost, passive investment strategies to Canadian consumers.  For investors seeking bare bones investment advice they are undoubtedly a superior alternative to high cost, actively managed mutual funds - which is where much of the wealth of Canadians is invested - to the tune of 1.5 trillion dollars.

However, in terms of investment management fees, there is clearly a race to the bottom underway.  This is the juggernaut faced by any industry that attempts to compete primarily on the basis of price.

As the competition for basic investment management services accelerates these fees will undoubtedly continue to decline.  Good for consumers, bad for Robo Advisors.

For a subset of investors - particularly those just starting out and those who want to be absolutely hands off and don't want to do any thinking about how their money is being managed - Robo Advisors have a commendable offering and are probably worth their fees (especially over shorter periods of time).

For Investors who are just a little more engaged with their money and want to avoid all costs where possible, BlackRock and Vanguard are just two examples of firms who offer investment solutions that are in many ways superior to Robo Advisors in terms of fees, sophistication and in some cases transparency.

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Danny MacKay is the founder of SeekAdvisor, a former Bay Street Executive and Industry Insider turned Investor Advocate.  If you have any questions or comments about this article, please feel free to reach out - info@seekadvisor.ca