Image Credit: Christophe Vorlet
By Jason Zweig | 3:55 pm ET Mar. 13, 2015
The financial robots have finally arrived in force.
With giant discount brokerage Charles Schwab launching its Intelligent Portfolios service this past week, the fledgling industry of automated investment advice is going mainstream.
Like the startup “robo-advisers” that preceded it, including Betterment of New York and Wealthfront of Palo Alto, Calif., Schwab can provide its service at low cost because the money isn’t touched by human hands.
A traditional broker or investment adviser would meet with you face-to-face and put your money in individual stocks, bonds, mutual funds or other securities. Robo-advisers, on the other hand, prompt you to fill out an online questionnaire. They then use software to generate and monitor a portfolio of exchange-traded funds, those low-cost investment bundles that are built to mimic the return of a market index rather than to try beating it.
Robo-advisers will automatically rebalance your portfolio if a rise or fall in the market skews how much money you have in any of the funds relative to the targets originally set for you.
They will also fine-tune the tax efficiency of the portfolio by selling some shares that have gone down during the tax year to offset gains elsewhere, for example.
The robo-advisers’ online questionnaires, which determine how your portfolio is invested, are no worse—and perhaps somewhat better—than the alternatives many human advisers use.
Having a machine manage your money isn’t for everyone. Some people need a human to hold their hand and stave off panic during a market crash. Some are uncomfortable with technology. Many face questions (on mortgages, insurance, estate planning or retirement income) that robo-advisers don’t answer—not yet, anyway.
But a flesh-and-blood financial adviser might not spread your bets wisely, might try timing or outsmarting the market, or might make errors a computer won’t. And humans charge more—a lot more.
You could pay at least 1% in annual expenses on a portfolio of mutual funds and another 1% for the adviser’s services—in total, 2% or more of your money annually.
With Treasury bonds barely yielding 2% and many analysts expecting the long-term return on stocks to average 5% or 6% annually, the cost of human advice could eat up half your expected return.
Robo-advisers, by contrast, are cheap. The annual expenses of the ETFs in Schwab’s new service will range between 0.04% and 0.48%, or $4 to $48 per $10,000 invested. Schwab won’t charge commissions or additional advisory fees on the ETFs. Betterment and Wealthfront also charge no commissions; their annual fees, including the cost of the underlying ETFs, also total well below 0.5%.
The Schwab service has quirks, however.
Some of the company’s own funds are among the cheapest anywhere; Schwab U.S. Broad Market ETF, an index fund that mimics the return on about 2,500 stocks, charges only 0.04% in annual expenses. But Schwab’s robo-portfolios won’t be dominated by such dirt-cheap, plain-vanilla funds. Instead, they will favor Schwab’s “Fundamental Index” ETFs, which charge up to eight times more.
These funds seek to outperform the market with baskets of companies ranked not by stock-market value but by their revenues, profitability and dividends.
Some investors—including Vanguard Group founder John C. Bogle, creator of the retail index fund—think the burgeoning popularity of the fundamental approach could hamper its future returns.
Mark Riepe, president of Charles Schwab Investment Advisory, which designed the portfolios, says the firm is confident that the potential outperformance of the fundamental strategy “should be enough to offset the higher expenses of those ETFs.”
Since 2005, the leading fundamental index has outperformed the S&P 500 by an average of 1.5 percentage points annually, according to Research Affiliates of Newport Beach, Calif., which pioneered the strategy.
Another wrinkle: Schwab will keep between 6% and 30% of your portfolio in cash, depending on your profile, and will earn a cut of the interest income. If you make a withdrawal, Schwab won’t charge a fee but will automatically sell a portion of your stock or bond ETFs to restore your level of cash to the original target.
You can prevent that, a Schwab spokeswoman says, by changing your online profile. But otherwise you could inadvertently trigger the sale of other funds you had been expecting to hold for years; you also could get hit with a capital-gains tax bill.
The spokeswoman says the software automatically seeks to sell the shares that will create the lowest tax liability.
Schwab’s entry into the market reinforces the message that robo-advisers are a legitimate alternative.
“A robo-adviser can make a lot of sense, especially for younger clients whose financial lives aren’t too complicated,” says Janet Stanzak, chair of the Financial Planning Association, a trade group with more than 23,000 financial planners as members.
Ms. Stanzak and Edward Gjertsen, president of the Financial Planning Association, expect many human advisers to start outsourcing portfolio management to the robo-advisers—and think that firms will have to expand their financial-planning services to justify their fees.
The rise of the robots could thus enable humans—and machines—to focus on what they do best. That should improve results for everyone, especially investors.
Source: The Wall Street Journal