This is a guest post written by Robb Engen at Boomer&Echo. Robb is a fee-only advisor and he blogs about Canadian personal finance and investing at Boomer & Echo. Reach him at firstname.lastname@example.org
How can you decide which online financial advisor is right for you?
An online financial advisor, or what the financial media and investment industry call a robo-advisor, is an online service that offers investors a choice of model portfolios that are typically built with low cost exchange-traded funds and regularly monitored and re-balanced for you.
It’s a hands-off approach that marries simplicity with technology to create an investing platform that appeals to just about everyone; from Millennials who might be getting their first taste of investing inside a tax-free savings account, to Gen Xers who are starting an RESP for their kids while simultaneously saving for retirement, to Baby Boomers looking to simplify their portfolio and thinking about winding down their careers.
Millennials in particular are shunning the traditional banking and investment model – one that has been riddled with high fees, conflicts of interest, stodgy face-to-face meetings, and pen-to-paper practices that should have been obsolete by now. Gen Y grew up banking online and has been quick to embrace the robo-advisor model, where they can open an account on their smartphone in five minutes and start investing.
Why use an online financial advisor?
One advantage of using an online financial advisor to manage your portfolio – especially in Canada – is that you don’t have to be in the affluent 1% of investors to build a broadly diversified and low cost investment portfolio. In fact, you can access all of this – including some light advice and handholding – for well below the cost of an equity mutual fund in Canada, which charge a highest-in-the-world average of 2.42%.
Depending on your portfolio size and which online platform you choose, investors can expect to pay a robo-advisor roughly 0.50% to manage an account, plus whatever fees are associated with the ETFs in your portfolio – which can cost anywhere between 0.05% and 0.60%.
Another advantage to online advice is that you automate the saving and investing process and then get out of the way. In his best-selling book, Thinking, Fast and Slow, professor and Nobel prize winning author Daniel Kahneman argues that people make better decisions when they rely on automated information systems.
“Statistical algorithms greatly outdo humans in noisy environments,” – Daniel Kahneman.
Research from Morningstar and SPIVA shows that individual investors achieve lower returns than their investing benchmarks due to bad behaviour such as performance chasing, market timing, loss aversion, overconfidence, and other cognitive bias. A rules-based formula, like the ones used by online financial advisors, can keep your portfolio on track by keeping your emotions on the sidelines.
Using a robo-advisor is also a good approach for those investors who don’t have the time or skill to manage their own portfolio, but who are savvy enough to understand that high-fee bank mutual funds are harmful to their wealth.
It was just two years ago that we were wondering if and when online financial advice would make its way to Canada. Fast forward to 2016 and Canada is now home to 13 online financial advisors, with new research suggesting that the adoption of financial technology services among Canadians will triple over the next 12 months.
So how does an investor decide which online financial advisor to use, and what type of questions should they be asking when trying to choose among all the options?
The first thing you’ll want to determine is how to get started. Check out each of the robo-advisor websites and get a feel for the user experience.
Do they offer a mobile app for your smart-phone or tablet so that you can monitor your account on the go? Are you comfortable with look and feel as you navigate through the website and mobile platform?Is there a trial or practice account where you can test drive the platform before you jump in with both feet? Read through the frequently asked questions on the robo-advisor’s website, search for reviews on financial blogs and news media, scan comments and social media for others’ experience.
Is there a minimum deposit required to open an account? Some online financial advisors offer to manage the first $5,000 or $10,000 for free.
How much does it cost to manage your portfolio? A typical management fee from an online financial advisor starts at around 0.50% per year and may drop down to 0.40% or lower as your portfolio grows. That means a $25,000 portfolio might cost $125 per year, while the annual fee on a $250,000 portfolio would cost about $1,000.
Keep in mind that someone with $250,000 invested in a typical bank mutual fund portfolio could pay upwards of $6,250 per year in management fees and trailing commissions. It doesn’t feel as painful because you don’t have to pay an upfront fee or write a cheque at the end of the year, but these fees get whisked away off the top of your returns, regardless of whether your portfolio made money or not.
You’ll want to ask what types of ETFs are used to construct your portfolio and what the average management expense ratio (MER) of the funds will be. Look for ETFs issued by companies such as iShares and Vanguard, who are known for low fees and a solid track record.
Remember that with an online advisor you’ll pay for the cost of the ETFs on top of the fee charged by the firm to manage your portfolio. So if the average MER of your ETF portfolio is 0.25%, and the online financial advisor charges 0.50% to monitor and rebalance your funds, your overall portfolio cost will be 0.75% per year.
Helpful resource: This online investment fee calculator can help you determine the overall cost of your portfolio based on the size of your account, portfolio type, and the amount of annual contributions.
If you plan to contribute to your account on a regular basis – monthly, for example – then ask whether your online advisor charges an additional fee per transaction. Most platforms include all of your trades for free as part of the overall management fee.
Finally, determine which of the robo-advisors are set up to manage portfolios in the province where you live. Not all of the robo-advisors are registered as portfolio managers in every province.