Of course, I wasn’t the only one shopping around for discounted stocks. Robinhood, Charles Schwab, TD Ameritrade, and Etrade all experienced an increase in new brokerage accounts as high as 170% in Q1 2020. With more time on our hands, free trades, and casinos closed, many Millenials and young investors are trying their hand at some Russian roulette on the market instead.
Even if you got lucky on a few bets though, managing a portfolio of hand-picked stocks in the long-term can be incredibly time-consuming. If portfolio managers are spending 40+ hours a week trying to beat the market, your chances of performing on par with the pros are slim.
Investing is still an important component of your financial strategy though. Here are a few reasons why you should incorporate investing in your financial routine:
Inflation is one of the main reasons that investing is important. The average inflation rate per year is 2%-3%, which means the purchasing power of your money decreases by 2%-3% annually. If you have extra cash, investing can provide a hedge against inflation by offering higher returns in comparison to a traditional bank account or money market.
2. Wealth generation
Investing is one of the best ways to generate long-term wealth. The combination of higher and compounded returns allows your money to grow exponentially over time.
3. Passive income
Investing can provide an alternative income stream alongside your paycheck. As companies focus more on efficiency and productivity during these difficult times, having a supplemental source of cash flow can act as a safety net if your job prospects are at risk.
One strategy towards investing in a diversified portfolio is buying index funds or ETF’s that follow the broad market, such as the Vanguard Total Stock Market ETF (VTI) or the S&P 500. When it comes to your finances though, you want your performance to be above average. Would you be happy receiving the average raise at work when your peers got an above-average boost in salary? Not me!
Investing for the Above Average Investor
Following the markets will still yield better returns in the long run in comparison to your traditional bank account. The above-average person, however, will want to ensure that their portfolio aligns with their risk preferences and specific goals. Growing vs. defending your wealth requires other risk and time considerations in addition to market performance.
Traditional financial advisors and planners can help provide more customized solutions, but the fees, time, or minimums may not always merit this type of service. So what can you do to raise the bar with your investment strategy when you still need a little help?
What is Automated Investing?
Robo-advisors are online platforms that provide automated and algorithmic-driven solutions for financial planning services. With the advancement of technology and artificial intelligence, robo-advisors came onto the scene around 2010, providing alternative options to traditional investment and financial services. Robo-advisors have lowered the barrier to entry for retail investors by offering lower fees and account minimums, providing a great option for tech-savvy, novice, and passive investors.
Robo-advisors offer a variety of services such as financial planning, wealth management, and automated investing. In this post, I will focus on the automated investing component.
Automated investing services are ideal for people who:
There are several platforms now that offer automated investing, most notably Wealthfront and Betterment. Retail banks, such as Charles Schwab and Chase, are beginning to offer intelligent portfolios as well, which can be an attractive option if you want to keep your banking and brokerage services consolidated.
There are many other robo-advisors who have come onto the scene over the past few years as well and provide unique benefits or niche offerings. Here are a few other players in the space:
I’ve used Wealthfront for several years now and it has been a great way to build a passive investment portfolio.
Pros & Cons(iderations)
Below are some of the pros and considerations I have found from personal experience using automated investing. Since my experience is specifically with Wealthfront, I will talk about the features this platform has provided. Many other services may offer similar benefits or drawbacks. I encourage you to research other platforms on your own though to find the service that best fits your needs.
1. Provides exposure to different markets and asset classes
Market research requires a lot of time and expertise. As much as I may like personal finance, I am not an investment professional. Wealthfront takes care of the work by identifying the appropriate asset classes across stocks, bonds, real estate, foreign investments, and commodities based on my investment profile.
2. Aligns portfolio allocation with risk profile
Managing risk is an important part of investing. Depending on your time horizon, you may want to take on more risk to generate higher returns or less risk to minimize losses. Wealthfront incorporates my risk preferences and adjusts my portfolio allocation accordingly to ensure it aligns with my goals.
3. Automatic portfolio rebalancing
As performance across different asset classes fluctuates within my portfolio, Wealthfront makes automatic adjustments to rebalance my asset allocation. This ensures that my relative exposure across different asset classes stays aligned with my risk preferences.
4. Low advisory and low fund fees
Expense ratios are a common oversight when investing in managed funds or indices. Many of the fees for the available funds in my employer’s 401(K) plan range from 0.5%-1.0%. Wealthfront in comparison charges a 0.25% management fees plus the fees associated with the index funds and ETF’s they invest in. Other services offer similar rates.
Because these services are automated and have less overhead, they are able to charge lower rates in comparison to managed services.
5. Tax-loss harvesting
Tax-loss harvesting is an effective way to minimize losses in underperforming assets. If an asset declines in value beyond an indicated threshold, robo-advisors can sell the asset (thus triggering a loss) and reinvest the proceeds into another highly correlated ETF or index fund. This avoids a wash sale (i.e. selling and buying the same security in a 30 day period) such that you can offset any capital gains with the loss from the initial sale.
1. Limited portfolio customization
Most robo-advisors will construct and maintain your portfolio based on an online profile you complete upon signing up. Making additional tweaks to the portfolio's securities though may not be possible. There have been some points in time where I would have liked to adjust the weightings myself but was not able to due to the limitations of the product offering.
2. Risk of wash sale when managing multiple portfolios
A wash sale event is triggered when you sell a security at a loss and purchase the same security within a 30 day period. If this happens, you cannot claim a loss for tax purposes.
If you choose to have more than one investment portfolio, let’s say through a robo-advisor and individual brokerage account, you want to be familiar with the securities that are in your automated investment portfolio. Otherwise, you may inadvertently trigger a wash sale by buying or selling the same security in your personal brokerage account.
3. Diversification across different platforms
Every robo-advisor will offer different benefits and drawbacks. It may sound like a good idea to invest across a few different platforms to diversify your options, however, doing so may impact your overall exposure. Automated investment services and individual brokerage accounts cannot “talk” to each other to ensure your overall portfolio exposure meets your risk preferences. A wash sale may also be triggered if one platform sells a security and another platform buys it within a 30 day period.
It is best to research various platforms and find one robo-advisor that fits your needs. If you still plan to supplement your portfolio through an individual brokerage account, Personal Capital is a great resource that can consolidate your holdings across different accounts to determine your overall portfolio allocation.
4. Internal transfers between investment accounts
If you have your own account through a robo-advisor, it may be difficult to transfer these funds to another investment account within the same platform. For example, if you want to combine two individual funds into one joint account with your partner, this option may be limited due to complex tax implications. Check with a representative first for more information around their terms and options before attempting to change your account.
Investing for the Long-Term
Automated investment platforms are a great way to get your feet wet with investing and grow a diversified portfolio. I believe the trend of robo-advising will continue to grow as younger investors gain more confidence in investing and look for technology-driven options that offer lower cost structures.
Although there are many economic uncertainties ahead, I believe the easy money is past us. I am now focusing on taking longer-term positions that will grow over time. To keep up the habit of investing and minimize volatility risk, I set up automated transfers each month to my Wealthfront account.
If you have a steady cash flow to cover your monthly expenses, savings for short-term goals, and an emergency fund, I encourage you to consider your investment opportunities through a robo-advisor. And if Wealthfront seems like the right option for you, use this link to get your first $5,000 of total assets managed for free!