Betterment or Financial Planner?

Investors are discovering automated investment services, such as Betterment, Personal Capital, or Wealthfront.

And as a result, they’ve been asking me questions about them and their benefits.  The pitch for these services is compelling: Using algorithms designed to optimize the performance of a investor’s portfolio, the automated investment services posit that they replace the value of a financial adviser.

First, let’s start with fees, as that’s  a salient aspect of these services’ value proposition.

The annual fee tends to be around .25%, but can be higher (.89% for Personal Capital) or lower (.15% for balances over $100,000 for Betterment).

When you consider the cost of traditional investment management, the delta in basis points diminishes as the portfolio grows.

Once you reach $500,000 or greater, the basis points between the 2 decreases, due to the way fees are set up to consider the balance  of a client’s portfolio .

So there’s the cost: For an investor just starting out with saving and investing, these automated investment services can save them money in fees.

Second, let’s look at the way automated investment services manage your money.

They start with a standard process of assessing your risk tolerance. Since this is assessed purely online or via the phone, there’s no opportunity to walk through what risk tolerance is, how much the investor understands it, and how it might change with contingent scenarios that a bull or a bear market would present.

This can put the investor at risk of not fully understanding what the consequences would be to truly see a part of their portfolio lose value in a bear market.

They may not understand asset allocations and how having a low correlation across a portfolio provides an investor with a portfolio with less volatility and a portfolio that has a better chance of reaching an investor’s financial goals.

Third, let’s look at how rebalancing occurs with automated investment services.  Rebalancing occurs at a frequency established when you set up the account, and there’s no variance from it.

But here’s the dirty trick with rebalancing: It isn’t always in an investor’s best interest to rebalance.  Simply saying that rebalancing once a year, say every March, will optimize an investor’s portfolio falls way short of being able to consider what may be happening in the short term with asset classes.

Automated investment services aren’t able to modify rebalancing timeframes after taking a qualitative look at the various asset classes.

And that’s where we go next: There’s no opportunity to make decisions informed by qualitative data. Automated investment services are run purely on quantitative data, removing a key aspect of optimizing your portfolio for long term returns.

Not being able to consider the fundamental aspects of an asset class’ qualitative data doesn’t provide the full picture into an asset class’ performance.

Now let’s consider tax loss harvesting.  It tends to make sense to annually review holdings for whether or not they are still good quality and still working towards portfolio growth.  For those that aren’t, and perhaps have eroded in value for a fundamental reason, or no longer fit an investor’s risk profile, it would make sense to sell and to harvest tax losses.

But simply selling for a gain or a loss, like an automated investment service would, goes directly against prudent portfolio management, because the recent performance of a long term holding doesn’t map to what the long term holding is intended to accomplish towards an investor’s financial goals.

Next up: Let’s consider what funds the investor’s portfolio are invested in.  Most of the automated investment services place an investor’s portfolio in a restricted set of mutual or exchange traded funds.  While the funds that they offer may be suitable for an investor’s portfolio, it does not at all mean that it is the best fund that is available overall.

And the last aspect in which automated investment services differ from a financial adviser: With a financial adviser, you are able to sit down in person with a financial adviser to walk through what your financial goals are, what your risk tolerance is, assess your financial literacy together, and to discuss what funds to invest in and why.

You can’t do that with an automated investment service, although you may be able to have a phone consultations with their service.

So, which method should you choose? I recommend an investor considers working with a financial adviser first, in order to construct their financial plan, and proceed to determine if executing the portfolio management through an automated investment service or through a financial adviser is best for them.

I think an automated investment service makes alot of sense for smaller portfolios.

But I pause at supporting them being utilized before creating a financial plan with a financial adviser.

It is only through the financial planning process that an investor is armed with a financial roadmap that provides a framework for not only how to meet their financial goals but also how to model a portfolio that will optimize their possibility of reaching their goals via asset allocation and the purchase of investments that uniquely best suit them.