Robo-advisors have increased in popularity in the past years but are they worth it? I was interested in seeing what they had to offer so I decided to try one out myself to see if these products are viable solutions for people looking to invest for their retirement. For those of you who are new to Robo-advisors, Wikipedia defines them in the following manner:
Robo-advisors or robo-advisers are a class of financial adviser that provide financial advice or investment management online with moderate to minimal human intervention. They provide digital financial advice based on mathematical rules or algorithms. These algorithms are executed by software and thus financial advice does not require a human advisor. The software utilizes its algorithms to automatically allocate, manage and optimize clients’ assets.
Below I have listed a number of popular Robo-advisors in Japan (the list is based on Robo-advisors that I looked up on 7th May 2020 and is not an exhaustive list).
- On Compass
- SMBC Robo Advisor
After reading about a number of Robo-advisors, I ended up choosing WealthNavi which seemed to be one of the most popular brands in Japan. The services that all the above brands offer seem to be all comparable where they charge around 1% for an account that invests in a diversified portfolio and performs rebalancing and optimisation.
How it works?
Once you set up the account and login you will be asked to start a questionnaire for the Robo Advisor to assess your risk/return objectives. For WealthNavi there are a total of 5 categories, with 1 being the most conservative and 5 being the most aggressive. The investment universe is limited to the below ETFs, however based on your risk appetite you will see a greater/smaller allocation to stocks. Here are the ETFs that your account balance will be allocated to:
VTI: Vanguard Total Stock Market ETF
VEA: Vanguard FTSE Developed Markets ETF
VWO: Vanguard FTSE Emerging Market ETF
AGG: IShares Core US Aggregate Bond ETF
GLD: SPDR Gold Trust
IYR: IShares US Real Estate ETF
TIP: IShares Tips Bond ETF
All ETFs are well known, provide good exposure to the market/asset class that they are looking to track with a very low expense ratio. I have added above the links to the fund profiles for those interested in looking at price/performance, fees, distributions, etc.
A Sample Allocation with a risk tolerance of 5.
(Allocation for 26th July 2019, initial investment 1,000,000, weights rounded at 2 decimal places)
|Emerging Market Stocks||VWO||148,698||14.20%|
Fees: 1% annual fee on your invested balance (excludes your cash weight), for investments over 30MM JPY 0.5% (SOURCE: https://www.wealthnavi.com/).
WealthNavi’s algorithm is set to perform rebalancing every 6 months. However, if any asset class deviates from its optimal allocation weight by more than 5%, rebalancing takes place ahead of schedule to bring the portfolio back to the optimal allocations. For rebalancing to take place ahead of schedule please note that you need a minimum balance of 500,000 JPY invested in the account, if your deposit is lower than this amount you will need to wait until the next rebalancing date for the portfolio to be rebalanced back to its optimal allocation.
After trying the service, I was able to come up with the following advantages and disadvantages from using Robo Advisors.
- Automatically generates an allocation based on your risk tolerance
Arguably, one of the main reasons why people choose Robot-advisors is because allocations and rebalancing decisions are done automatically based on pre-defined rules and algorithms with some form of portfolio optimisation taken into account. This is a great advantage if you want to avoid the hassle of having to review your portfolio and having to regularly update the allocations yourself.
- No Transaction costs when rebalancing portfolios
Buy/Sell orders in your brokerage account will usually result in transaction costs, however rebalancing done by your Robot-advisor will not result in you incurring these fees. You will be charged a flat fee as a % of your account balance.
- Tax-efficient rebalancing
The optimisation algorithm (at least for WealthNavi) is able to factor in taxes when realising gains/losses and offsets them to ensure steady returns whilst minimising tax liabilities.
- High Fees
Arguably, the fees that Robo-advisors charge is one of the biggest drawbacks from this service. Especially if you are paying 1% to hold a balanced portfolio of ETFs this is something that you might want to consider doing yourself if you are able to sit down, measure your risk appetite and do some analysis based on your risk return objectives. There are a lot free softwares out there that perform portfolio optimisation. There is a limit to the transparency that each Robo Advisor will provide in terms of rebalancing rules (especially if this will end up revealing trade secrets) but from what I can gather is that a lot are based on Modern Portfolio Theory and will place your portfolio somewhere on the efficient frontier based on your risk/return constraints.
- Value lost from automation/not too much customisation
Some of the value that financial advisors can offer is the tailored financial advice they can give to individuals based on their financial situation and objectives. The bucketing and categorisation that current Robo-advisors perform is still limited in my opinion and is not able to capture the cognitive aspects and intricacies of the investor’s mind.
I believe that the value of Robo-advisors depends a lot on how much time you want to spend in looking at your portfolio. If you are just happy to have your money invested automatically in a diversified portfolio and want to spend minimum time and effort in working out portfolio weights, buy/sell timings I do see a value in this service. If instead you are happy spending some time reviewing your allocations and making your own investment decisions, I believe that spending additional fees on a Robo-advisor just ends up hurting your returns and you have much cheaper ways for obtaining comparable results. There are also a lot of ETFs out there which already provide a very good level of diversification at extremely competitive management fees.