The Boost: Robo advisors - set it but don’t forget it.

Do you use a robo advisor? Many companies offer robo advisory or automated investing, such as Wealthfront, Betterment, Schwab, Fidelity and more. These platforms are for individuals who want to outsource investment management at a lower cost than a human advisor. Wealthfront and Betterment charge an annual 0.25% advisory fee based on current assets, or $250/year for each $100,000 invested, compared to the median 1.00% for a wealth advisor. These fees increase as your assets grow.

This week we provide an overview of how robo advisors work and asset allocation considerations.

🧠 What you need to know

With Wealthfront and Betterment, you can set your investment amount, choose a risk profile, and let them take care of the rest with just a few clicks. The platform allocates your funds to a diversified basket of low-cost exchange-traded funds (ETFs) and automatically rebalances and conducts tax-loss harvesting. You can also customize your portfolio by adding or removing securities.

Below is Wealthfront’s Classic Portfolio with a 10 out of 10 risk profile – in other words, a higher risk portfolio based on their scale. Wealthfront uses the Modern Portfolio Theory, a popular framework for building diversified portfolios based on a long history of data.

Investing with a robo advisor is convenient, but it's crucial to understand your portfolio's allocation and risks. You don't want to be surprised by your returns like this Betterment user:

Being aware of potential underperformance is key. Robo advisors optimize returns based on your risk profile, but asset allocation can significantly impact returns.

A deeper look at diversification tradeoffs:

See how automated asset allocation impacts returns with Wealthfront’s Classic 10/10 risk portfolio’s allocation to ETFs:

  • Vanguard Total Stock Market ETF (VTI): 45%
  • Vanguard Tax-Exempt Bond Index ETF (VTEB): 16%
  • Vanguard FTSE Developed Markets ETF (VEA): 15%
  • Vanguard FTSE Emerging Markets ETF (VWO): 15%
  • Vanguard Dividend Appreciation ETF (VIG): 9%

Over the past one year, the portfolio returned 11.7% and it returned 51.6% over the past five years. In contrast, the S&P 500 returned 17.6% and 78.8% over the past one and five years, respectively. Over five years, a $100,000 initial investment in the portfolio would have returned $51,600 compared to $78,800 invested in VOO, an ETF that tracks the S&P 500.

The ETFs in the Wealthfront portfolio had lower returns than the S&P 500. The worst performers were the allocations to emerging market stocks (VWO), dividend growth stocks (VIG), and municipal bonds (VTEB). However, they were less volatile, which is an advantage of a diversified portfolio.

If this allocation matches your risk profile and goals, there's nothing wrong with it. For example, you may prefer it because it reduces your exposure to the Magnificent Seven. But it's important to understand why it's right for you and ensure performance meets expectations so you aren’t surprised by results over the next five years and beyond.

🤝 How can Mezzi help?

If you have an automated investing account, Mezzi assesses :

  • changes in allocations
  • performance against benchmarks like the S&P 500
  • allocation vs. your other investment accounts
  • performance vs. your other investment accounts or advisor-managed accounts.

If you want to set up your own “set it and forget it” portfolio without paying an advisory fee to a robo advisor, Mezzi helps you monitor it and provides steps and reminders for executing tax-loss harvesting and saving on ETF fees to boost your returns and save thousands.