Robo-Advisors vs Online Brokers vs RIAs – Which is Best?

The rise of the “robo-advisor” is hard to ignore. Startups Wealthfront, Betterment, Personal Capital, and others have shaken up the managed assets scene by letting algorithms determine the best allocation of capital.

Investing with a robo-advisor has given investors the ability to accomplish long term investment goals with a much lower cost over using a traditional advisor.

A similar trend of lower costs has been seen with the online brokers. All the major brokers charge $9.99 or less per trade, with a variety of firms offering trades at half that rate, $4.95 or lower.

So which is the better choice: park your capital with a so called robo advisor and let the algos direct your portfolio, or take the bull by its horns and trade for yourself?

Let’s break down the differences and find out.

Investing with a Robo Advisor

The main driving force behind the movement towards investing with a robo advisor is cost savings. Investors, especially Gen X and Millennials, do not care to pay an extra .75% or more per year to have face to face interactions with a traditional advisor. Compared to some mutual funds, the savings are greater.

robot advisor

Wealthfront, the current market leader in the automated investments space, in June announced it had crossed over $1 billion in assets under management (AUM). While still a drop in the bucket considering the market for managed assets is over $1 trillion, the $1 billion mark is proof of the pudding. Automated investing does work.

Wealthfront charges a flat .25% management fee per year with the first $10,000 of any portfolio being managed for free. On a $100,000 portfolio this comes out to only $18.75 per month for a completely automated solution. For comparison sake, $18.75 wouldn’t even pay for two stock trades at a big name broker.

Another advantage that robo-advisors offer is constant portfolio tweaking to keep the portfolio balanced, reinvesting dividends, and minimizing the effects of taxes via tax-loss harvesting (here’s a great video breakdown on tax loss harvesting, however the concept does have its contrarian data). Wealthfront and Betterment both do a very good job in this area.

Investors should note though that not all robo-advisors are equal. Fees can vary so it is important to do a proper comparison before choosing one. A good read on the differences separating Wealthfront from its competitors can be found on Quora.

In summary, the three primary advantages of a robo-advisor over investing on your own:

  1. Less risk – By investing in a diversified portfolio tailored to your predefined risk level, you are going to be far more in sync with the overall market averages.
  2. Minimal time commitment - An automated solution means all of the research, due diligence, balancing, etc are done for you. On a day to day basis, this time savings adds up real quick.
  3. Peace of mind – Trading on your own is stressful and not for the faint of heart. With a robo-adivsor, you can sleep each night knowing your portfolio is catered to your risk tolerance, professionally balanced, and takes advantage of sophisticated techniques such as tax-loss harvesting.

Trading with an Online Broker

While the robo-advisor “revolution” is still in its infancy, online brokers and RIAs have been around for some two decades connecting investors to the market. Brokers have evolved to provide clients with not only just discounted trades, but the platforms, tools, research, etc. to invest successfully.

trading computer

By trading your own portfolio, you remove any yearly management fees charged and pay only the cost of buying and selling. The less you trade, the more you save. That said, to properly maintain a balanced portfolio like one Wealthfront, Betterment, or an IRA offers, trades have to be done effectively to minimize cost.

With an online brokerage account, you are also in full control of your financial destiny. For many, this is a lot of pressure, but for those that put in the time, the reward potential is far greater (while assuming more risk naturally).

Time is the big x-factor. If you struggle to find time to even check in on your portfolio each day and track your holdings upcoming earnings dates, then you are putting your portfolio at extensive risk. Fortunately, the online brokers provide great tools, in most cases included with your account for free, to help keep a close eye on your nest egg.

For a full comparison of the online brokers, read the StockBrokers.com 2014 Broker Review.

In summary, the three advantages of trading independently through an online broker vs passive and actively managed assets:

  1. Larger earnings potential – Putting 5%, 10%, 15%, 20% or more of your portfolio into a single position is risky, but is how skilled investors outperform the market averages (see Will O’Neil’s CANSLIM recommendations for proper portfolio allocation).
  2. Potentially lower fees – Depending on your activity level (ie how frequently you trade), the price you pay per trade, and your portfolio size, trading on your own can be cheaper than investing with a robo-adviser. Compared to mutual funds and investment advisors, the savings are vastly in favor of trading independently.
  3. Complete control - People fear flying yet are comfortable driving when the risks are 1000 fold greater of something bad going wrong. That’s because people are more comfortable with risk when they feel like they are in control. The same mentality applies to investing.

Using an RIA

A registered investment advisor (RIA) is someone who is certified in financial planning and asset management. Traditionally, RIAs manage money for accredited investors, institutions, and the like. All RIAs are registered with the SEC alongside the individual states they operate.

RIA advisor

(Image credit SunSentinel) The primary reason investors select an RIA to manage their money centers around the value of having someone to meet face to face or talk to over the phone. An RIA serves as the backbone of your portfolio, ensuring all your specific investment objectives are met.

Naturally when things go sour, like during the 2008 – 2009 financial crisis, investors tend to lose trust in their financial guru. When times are good, like 2013 when the S&P 500 had its best year since 1997 returning 29.6%, RIAs and other professional asset manager are super heroes in the eyes of their clients. This is all part of the business.

Speaking of returns, RIAs can also boast more attractive returns (and in some cases lower fees) over mutual funds. RIAs do not all follow the mold of a fully diversified portfolio; strategies can vary depending on the client needs and the manager.

With so many options to choose from, services like Covestor were created to serve as a marketplace of advisors and professional asset managers, giving clients greater transparency and in many cases a closer relationship with the manager.

A good quick introduction article on RIAs and the current state of the industry can be found at Investopedia. To follow the industry news and keep up with the latest I read RIABiz.com.

In summary, the three advantages of using an RIA vs a robo-advisor or trading on your own:

  1. The relationship – The main bulk of the yearly management fee is paying for the ability to pick up the phone and talk to your money manager about the latest activity in your portfolio.
  2. Flexibility – A good RIA will be able to cater to your specific needs. Predefined strategies are laid out for all clients naturally, but that doesn’t mean a customized solution is not available.
  3. Performance – While this varies greatly, some RIAs can outperform the market averages while savings clients money over other more expensive financial vehicles.

Cost Comparisons

Let’s look at several hypothetical scenarios comparing the yearly costs associated with having your portfolio managed by a robo-advisor vs traded by yourself vs managed by an RIA.

To calculate costs, we will assume Wealthfront’s .25% yearly management fee, StockBrokers.com’s 2014 #1 rated broker TD Ameritrade’s $9.99 per trade, and a 1.25% yearly management fee charged by an active investment manager. Both Wealthfront and TD Ameritrade do not charge any additional yearly fees beyond the presented costs.

Lastly, it important to note we are just look at the costs associated with these different services. Naturally, the returns observed over time are a massive piece to this puzzle and should not be overlooked.

Scenario A: $10,000 in assets managed vs 12 trades per year (once per month)

In this scenario, we are looking at a young professional just getting started in his or her career that does not yet have a substantial retirement account.

  • Robo-advisor: $0 (accounts up to $10,000 are managed for free)
  • Invest on your own: $119.88 (12 x $9.99)
  • RIA: $125 (note most RIAs will not accept accounts this small)

Winner  = Robo-advisor

Scenario B: $100,000 in assets managed vs 24 trades per year (twice per month)

Here we are looking at someone who has established themselves in their career and is actively building their nest egg. We will assume that someone managing their own portfolio in this case would be slightly more active with their trading to maintain proper diversification, manage multiple positions, etc.

  • Robo-advisor: $225 (accounts up to $10,000 are managed for free; thus, $90,000 x .25%)
  • Invest on your own: $239.76 (24 x $9.99)
  • RIA: $1,250 ($100,000 x 1.25%)

Winner = Tie between robo-advisor and investing on your own

Scenario C: $1,000,000 in assets managed vs 48 trades per year (four times per month)

In this final scenario, we have someone who is further along in their career and is well on their way towards retirement. Once again, because of the larger portfolio size, we will assume any individual investing on their own in this case would be more active.

  • Robo-advisor: $2,475 (accounts up to $10,000 are managed for free; thus, $990,000 x .25%)
  • Invest on your own: $479.52 (48 x $9.99)
  • RIA: $10,000 ($100,000 x 1.00%; as portfolios scale in size, management fees tier down)

Winner = Investing on your own

Cost Conclusions

These three scenarios show us that as the portfolio increases in size, so do the management fees charged by robo-advisors and RIAs. Proponents of an RIA will argue that the rise in cost is justified because there is more at stake, which is certainly valid.

On the other hand, one of the key reasons why $100 million+ in venture capital has poured into the robo-advisor space is that returns from mutual funds, RIAs, hedge funds, etc have historically, on the whole, failed to keep up with the market averages.

The belief is that if you truly “set it and forget it” over several decades, a robo-advisor will outperform the competition after fees. Tax loss harvesting and more importantly compounded returns are big over time. Every year that extra 1% or more in management fees has to be made up with market out-performance.

Apart from managed assets altogether you have trading on your own. As we should expect, the costs from doing it yourself are going to be far less over time, especially as the portfolio scales in size. That said, the value of time is a huge x factor that should not be overlooked.

So Which is Best?

Do you want to manage your own investments or have someone (or algorithms) manage them for you? That is the ultimate question.

For the vast majority of Americans, especially those that do not have the time to do the homework and work towards becoming a better investor day in and day out, a managed solution is going to be the safer way to go hands down.

Questions to ask yourself in choosing between a robo-adivsor and an RIA:

  1. “How important is human interaction to me?” If that occasional vocal reassurance that the ship is sailing in the right direction matters to you, then an RIA will be the best route for you. Just know it comes at a price tag of roughly 1% per year.
  2. “Do I believe in mass data and algorithms?” If you believe that decades of market returns data and asset manager performance is the truth, then a robo-advisor is for you.
  3. “Am I emotionally committed to the long haul?” Investor emotions can devastate any portfolio. Selling at the bottom of the 2008 – 2009 market crash would have left your portfolio and mental state in shambles as the market rallied back over the years thereafter. Regardless of which you choose, keeping your emotions at bay is critical to long term success.

Really, risk appetite and comfort are the keys. When managing our retirement, the money that is there to maintain our lifestyles until you pass away (and hopefully pass some on to your family), do you want that future in your own hands or someone else’s?

For me, I love trading and investing. The market is a big game, the ultimate game besides life itself, and my goal is to conquer it. Whether that means riches or simply looking back after several decades and realizing I would have been better off buying SPY (ETF replicating the performance of the S&P 500). To me the time invested is worth the potential reward.

That said, I am young at only 28 years old, married with one child currently, and make up just one scenario of hundreds.

Hopefully this article can atleast help break down the differences between the options that are available to you. An educated investor is a powerful investor. Regardless if you are driving the boat or someone else at the helm, atleast you’ll now understand the different ways to reach a fruitful and prosperous retirement.

Note: If you are curious about diving deeper, here are some interesting articles to consider:

  • The Reasons Why Human and Robo-advisers Will Soon Converge – Investment News
  • 4 Things To Know About ‘Robo-Advisors’ – ETF.com
  • How one ‘robo-advisor’ got $25 billion on its platform with a Mint.com mindset- RIABiz.com

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