Let’s say you’re a small-time investor. Hmm, that name sounds a little condescending.
Let’s say you’re a mainstream investor. Your name is neither Goldman, nor Sachs, but you’ve accumulated enough money that it would have impressed your younger self. When it comes to managing your investments, however, you’d like to hire the job out but financial advisors charge more than you want to spend, and you’re not sure how to choose a good one, anyway.
Hey, isn’t the Internet supposed to make things easier and cheaper?
Sure it is, and one promising portfolio management app comes from an unlikely source. Last year I wrote about Wealthfront, which was then peddling an expensive beat-the-market service that, I argued, was extremely unlikely to beat the market.
Well, Wealthfront has relaunched (which is web-speak for “reformed”). They’re positioning themselves against Betterment, another simple investment account that MintLife has explored. (Betterment is a Mint.com partner.)
Now, when you sign up for WealthFront, it will build a customized portfolio for you based entirely on low-cost index funds, mostly from Vanguard. The software asks you a few questions about your risk tolerance and then presents your portfolio in full—all before you tell them your name or hand over a dime. “We have an open-source philosophy,” says Wealthfront founder, Dan Carroll. If someone wants to take the Wealthfront-recommended portfolio and implement it without paying Wealthfront, Carroll isn’t worried about it. “People are busy kicking ass in their trade and don’t necessarily want to do it themselves,” he says.
The most exciting feature of Wealthfront is the price: Free (not counting the minimal underlying ETF expenses) for up to $25,000 and 0.25% of assets annually after that. Betterment, by comparison, charges 0.9% a year for the first $25,000. (The minimum opening balance for Wealthfront is $5,000; Betterment has no minimum.) “We have been in process of reviewing our fee structure for several months and expect an update soon,” says Betterment’s Jon Stein. “I expect us to be more than competitive with their offering.”
When these guys get into a price war, average investors win.
Rebalancing is when you reset your portfolio to your chosen asset allocation. In other words, if you started out at 60% stocks/40% bonds, but your portfolio has drifted to 70% stocks/30% bonds, you sell some bonds to buy some stocks and get back to your original risk tolerance. Financial writers generally tell people to rebalance once a year, or when your allocation gets some percentage out of whack.
In the real world, rebalancing is like cleaning out the garage: People put it off forever if they can get away with it. It means spending hours on the websites of your various investment account providers, and it’s also a mental hurdle to sell the stuff that has been making you money lately in order to buy more of the stuff that has been losing money. (It helps to think of it as selling expensive assets to buy cheap assets.)
This is where services like Wealthfront and Betterment really shine. You never have to rebalance because the software does it for you.
The old school
The biggest competition for these upstart services comes from target-date and lifestyle funds from big discount mutual fund companies like Schwab, Vanguard, and Fidelity. Vanguard’s LifeStrategy funds, for example, are based on low-cost Vanguard index funds, and you can choose from among four funds with different risk profiles, ranging from 20% stocks to 80% stocks. These funds are also automatically rebalanced and charge a tiny management fee (about 0.15%). Similarly, target-date funds (TDFs) are pegged to your retirement date and offer a diversified mix of stocks and bonds that gets more conservative as you get older.
I asked Carroll why someone should use Wealthfront, rather than one of these funds. “TDFs essentially pinpoint your risk tolerance on a single variable, i.e. your age, and give you a portfolio based on it,” he says. “We actually try to make it even better by looking at many more variables to pinpoint your risk tolerance. Even for the same age group, people might have very different financial situation and risk tolerance, and we capture those differences.” He added that Wealthfront customers get an email every quarter asking them to review their financial situation to see whether anything has changed that would impact their need or ability to take risks. Target-date funds don’t do that.
The taxman cometh
Attention personal finance web startup geeks: I have a wish for you.
One thing that no all-in-one investment product does well is manage taxes. Almost everything complicated about investing comes down to taxes. We have all these different accounts (401(k), Roth IRA, 529 college savings plan, taxable brokerage account) that are taxed in different ways.
To make matters worse, different investments are taxed differently. Interest on bonds is taxable at your ordinary income rate. Most stock dividends are taxed at a lower rate. Then there’s short-term and long-term capital gains rates, which range from zero to 35%, depending on… Oh, let’s not get into it.
What this means, in short, is that if you have a mix of taxable and tax-advantaged investment accounts, like a 401(k) plus a regular brokerage account, it’s a bad idea to reproduce the same portfolio in both places. You’ll pay more tax than necessary. Automated services like Wealthfront or target-date funds don’t take this into account. They can build you a nice diversified portfolio, but if it doesn’t consider your tax situation, it’s not the best portfolio for you.
Traditional financial advisors are good at playing this tax game. While Wealthfront can’t peer into your 401(k), that doesn’t mean it couldn’t ask. There’s no reason an automated service couldn’t ask for your 401(k) balance and investment options, crunch the numbers, and come up with a portfolio that is diversified, low-cost, and tax-efficient. That’s my dream. Hmm, maybe I need to dream bigger.
Having said that, however:
-If your current investment approach involves expensive actively-managed funds or just a mishmash of funds and individual stocks accumulated over the years, moving everything to one of these services would be a huge improvement, taxes or no taxes.
-Most people have all of their investments in tax-advantaged accounts, where you don’t have to worry about tax consequences because everything is taxed the same way. Both Betterment and Wealthfront offer traditional and Roth IRAs.
Is one of these super-simple services for you? Here’s a comparison chart*:
|Fees (excluding underlying mutual fund/ETF fees)||0.35% ($88)||none||none|
*Based on a $25,000 investment
One final thought: You, and only you, know your portfolio, your tax situation and your tolerance for risk. Wealthfront and Betterment are both excellent apps and it’s up to you to figure out which one is the right fit for your personal needs.