I want to start by making it clear that this post is not meant to bash robo-advisors. They are not dangerous, and moving from high-fee mutual funds to a robo-advisor would likely be a big improvement in your personal finances.
Their relatively low fees, ease of use and focus on index investing have been a wonderful addition to the investment landscape. For many Canadians, robo-advisors may be the best current compromise between simplicity and fees. The slightly more hands-off approach may also help investors stay the course and avoid common investing pitfalls like trying to time the market.
But it’s worth understanding what you’re paying for, and if the value proposition makes sense for your situation.
Robo-advisors are not really what the name suggests. Many of them do have human financial advisors that you can speak with. The key feature is that they provide digital platforms that automate the management of an ETF portfolio. They offer easy account set-up, slick user-interfaces, investment advice, portfolio management, and low fees. There are a number of providers in Canada:
- Questwealth Portfolios
- BMO Smartfolio
- RBC Investease
- Wealth Bar
- Just Wealth
- Nest Wealth
They generally charge a management fee somewhere around 0.4% on top of the MERs (fees) of the underlying ETFs, which typically average around 0.2% — although some have much lower or higher fees and this generally depends on account size, so make sure to check. Depending on the robo-advisor and direct-investing account provider, there may also be differences in account or trading fees that favour one or the other.
Let’s just look at the impact of an additional 0.4% fee on long-term portfolio returns. If you invested $10,000 per year and earned a 5% annual real (after subtracting inflation) return, after 40 years you would have just over $1.2 million. If you had instead earned 4.6% (5% – 0.4%), you would have just under $1.1 million. In this example, avoiding an additional 0.4% fee could increase your overall returns by around 10% or $112,000. The actual fee difference will depend on the specific robo-advisor and direct-investing provider that you would use. This is just meant to give you a sense of how meaningful small differences in fees can be over the long term.
So what advantages do robo-advisors claim to provide for this fee? You can look for yourself on their websites, but here is an overview along with my take on whether these advantages might apply to you:
Ease of use
Robo-advisors generally live up to this. If you have not moved to low-cost index investing because you are intimidated, or just don’t know where to start, then this alone is worth the fee. But don’t overestimate the work involved in buying an ETF. You need to open a direct-investing account, but then it just takes a tiny bit of math and a few clicks. You only have to go through the account opening process once. You will be investing for decades.
Robo-advisors also make it easy to set up regular automatic contributions. This can be incredibly valuable to help keep investors on track. If you want to purchase ETFs directly, you will have to do it manually.
Rebalancing is pretty simple, but it may seem like a lot of work to some. The thing is, there is now a large selection of all-in-one portfolio ETFs available to Canadians. With one ETF, you can hold a globally diversified portfolio of stocks and bonds, for a MER as low as 0.2%. You just need to pick a fund with your desired asset allocation, whether it is
- 20/80 (e.g., VCIP, XINC);
- 40/60 (e.g., VCNS, XCNS, ZCON);
- 60/40 (e.g., VBAL, XBAL, ZBAL);
- 80/20 (e.g., VGRO, XGRO, ZGRO); or
- 100% equities (e.g., VEQT, XEQT).
Because it is all held within one ETF, the rebalancing happens automatically. You don’t have to do anything.
If all of your investments are in registered accounts (e.g., TFSAs and RRSPs), the tax-loss harvesting would not provide any benefit. You cannot get credit for capital losses in these accounts. This means that for most Canadians, it is not relevant.
Even in taxable accounts, it may not be significant for your situation. Tax-loss harvesting involves the selling of one ETF at a capital loss and using those funds to purchase a similar, but not identical ETF. This will maintain the asset and geographic allocation of your portfolio but allow you to carry forward a tax credit for capital losses. It sounds like a loophole, but it is legal if done correctly and many sophisticated investors and portfolio managers to it.
Tax-loss harvesting does not permanently reduce your tax liability, it only allows you to shift it further into a future. There is a benefit to that, but its significance depends on your situation. Most Canadians will not incur significant taxable capital gains until they start drawing down their portfolio in retirement, and the tax rates on capital gains are low. Also, if you first bought the funds following a stock market downturn, it may be quite rare that your funds fall enough in value for a significant capital loss to be claimed.
Robo-advisers advertise this as a key benefit. But discount brokerages generally offer Dividend Reinvestment Plans (DRIPs), which allow investors to use their dividends to automatically purchase additional shares for the same ETF. There are no fees associated with DRIPs.
Also, it’s not necessary for your dividends to be reinvested immediately. Even without a DRIP, as long as you are investing new funds at least once a year, you can simply include your dividend income in these purchases. The difference these two approaches would have on your long-term returns is negligible (see The DRIP Myth). If you are not investing new funds every year, that probably means you are relying on your portfolio for income. In that case, you will be spending your dividend income anyway.
As I said, I think robo-advisors are great. They may even be the best investment solution for your situation. But to know whether they are the best option for you, you need to understand what they provide compared to the less expensive alternatives.