Ivanna Hampton: Some investors are choosing to go digital for financial advice. Robo-advisors charge lower fees than traditional financial advisors. They tend to be more accessible to investors with smaller account balances. The digital investing platforms come with advantages and disadvantages. Morningstar has evaluated 18 leading robo-advisors and ranked the best of 2023. Morningstar Research Services’ portfolio strategist Amy Arnott and senior manager research analyst Gabe Denis are joining Investing Insights to discuss what the team has found.
Amy, let's start off with an explainer. What's a robo-advisor?
Amy Arnott: So a robo-advisor is a type of investment management where you go to a website and the website uses a portfolio advice engine or a series of algorithms to manage your money for you. So typically they will start out by asking you a series of questions about your goals, your time horizon, your risk tolerance, and then they match you up with a portfolio. Typically, one of at least five different risk options ranging from conservative to aggressive, and they will automatically rebalance that portfolio for you to keep the allocations in line with the target levels over time.
Hampton: So Gabe, what kind of investor would benefit from using a robo-advisor?
Gabriel Denis: So there's a few different profiles of investors that would benefit from a robo-advisor. One of the most common kind of use cases that we can see is sort of that investor that's kind of taking the bridge between going fully self-directed on a cheap brokerage platform online. Think of your Robinhood on your phone or something else on a computer. And then those that are actually going to a traditional wealth manager that's going to have really comprehensive estate planning advice and so on and so forth, someone who's just starting out wants a little bit of guidance with their investing is usually the profile of what we would imagine would get the most value out of a robo-advisor.
Hampton: Did you see any surprises this year?
Denis: One of the biggest surprises is that that profile you might think would be for a younger investor and there were certain services that told us that their median age did tend to go towards your late twenties, early thirties, early accumulators. But there were several services that actually let us know that their investor base actually skewed somewhat higher than we were expecting for these robo services. So think late forties, early fifties or something like that. So there are just a wider variety of investors taking advantages of these services than we originally anticipated.
Hampton: And Amy, you guys released a report last year. Did you see any changes between last year and this year?
Arnott: Yeah, we did. We were actually happy to see that several providers made improvements partly based on our initial report. So we saw a couple of providers reducing their fees, lowering their minimums, adding things like tax loss harvesting, adding hybrid advice options. So those are some of the main changes we saw between that last year and this year.
Hampton: And you just mentioned tax loss harvesting, some robo-advisors offer this. How would you describe it? Is it a nice to have service or a must have service?
Arnott: So tax loss harvesting involves selling a security that has declined in price so that you can use that realized loss to offset realized gains that you might have elsewhere in the portfolio. And so they'll sell one security and then replace it with something that is similar but not identical. And this can definitely improve your tax adjusted returns over time. So if you're saving for retirement in a tax deferred account like an IRA, you don't need this service. But if you're in a taxable account, especially if you're in a higher tax bracket, it is definitely more of a must have.
Hampton: All right, Gabe, so what are some of the limitations of digital investment advice?
Denis: So digital investing advice, one of the biggest limitations is that what you see on the computer is likely what you're going to get in terms of the type of sorts of recommendations and so on and so forth that you would get from the service. What we found is that there's been a lot of research showing that a lot of investors, even if the advice is fairly straightforward, often want that human touch when it comes to actually making that final decision in terms of here's how you should invest lump sum of cash that you have, or here's how you should rebalance your portfolio, so on and so forth. And while a lot of the providers that we assessed have made significant strides in terms of making digital advice incredibly comprehensive in terms of what you can get service there, still, there are many investors that just want to have a human proverbial or sometimes literally hold their hands when it comes to some of those tougher decisions.
Hampton: Amy, it seems like robo-advice and traditional human advice would operate in different or separate spaces. How are the lines blurring between these two?
Arnott: Yeah, so when Robo-Advisors first started coming out about 15 years ago, a lot of people were saying that they were really going to encroach on traditional wealth management firms and potentially replace a traditional financial advisor. But that really has not happened. As Gabe mentioned, I think over time what people have found is that investors really do want to be able to talk to a human being when they're making major decisions with their money. That's why most robo-advisors now offer some type of access to a human being, either through chat features or on the phone, something like that. And as I've mentioned earlier, we've also seen several providers roll out hybrid advice offerings where they have the basic investment management, which is purely digital, but then there might be a higher price premium service where you get additional financial planning services and the ability to talk to a human financial advisor. At the same time, on the traditional side, we've seen more and more financial advisors adopting digital tools like model portfolios or direct indexing. So as you said, the lines are really blurring between those two different areas.
Hampton: So fees, everyone seems to talk about them. Robo-advisor fees tend to be cheaper than the traditional human advisor. Gabe, can you give as an example of that?
Denis: Where to start? So Robo-advisors almost across the entire spectrum have been significantly cheaper than many of the traditional wealth manager offerings that you would be expecting to see on the market today. Some of the cheapest options that we assessed during this most recent landscape, some of them had zero advisory fees on the very top ans would get their fees through different structures. The median was only 25 BIPS for investment advice overall in terms of the overall management fee. And many of them we're using, if not exclusively, then largely cheap ETFs to get sort of broad exposures to the portfolio allocations that they suggest. Just anecdotally trying to find what your kind of starting fee is for a traditional wealth manager usually gets you to the realm of 1%, 1.5%, 2%, depending on if you're going to sort of a larger broker house. Or you can negotiate with a larger RIA. But that's kind of a harder thing to assess on a holistic basis like we have for these robos. So the fee difference is very stark in many cases.
Hampton: So Morningstar published a report, best Robo-Advisors Advisors of 2023. Amy, what did your team take into consideration?
Arnott: So we tried to really zero in on the factors that we think will make the biggest difference to investor outcomes. And so we focused on looking for low fees, taking into account both the advisory fees and the fees on the underlying funds. The quality of investments and portfolio construction, the quality of the organization and the people behind the platform, and then also the breadth of services. Do they offer things like tax loss harvesting or financial planning services? So in each of those four areas, we gave each provider a score from one to five, and then we weighted those scores to come up with an overall assessment. So the weighting was 30% based on price, 30% based on quality of investments and portfolio construction, 20% on the provider and people side. And then the remaining 20% was based on breadth of services.
Hampton: Let's focus on the top three. Gabe, who came in third place and why?
Denis: So Schwab Intelligent Portfolios came in third for our assessment this year, and it continues to be one of the most impressive offerings across many of the aspects that we assess. For most investors, it's completely free and it provides really comprehensive advice for purely digital, but still with a lot of different facets, including how to think about retirement income drawdowns and very comprehensive goals-based planning for pretty much all stages of life.
And then once you get to a certain asset level, you actually have the option to opt into the premium service, which gives you unlimited access to CFP advisors only for an initial planning fee and then ongoing subscription fees as well. It's only real major flaw that we assessed this last time around is the fact that most of its portfolios are very cash heavy. And this was something that led to some controversy in the past for the offering and it has made some steps to improve this, most specifically being from moving that cash allocation from a very low yielding cash sweep to a higher yielding government money market account. But we have found that if you sort of compare the returns that you would've gotten with other providers that don't have such high cash burdens, you are still getting quite a bit of a drag on those portfolios. So it's something to keep in mind and hence why it's not higher assessed on our spectrum.
Hampton: Amy, what about the runner up?
Arnott: So number two was Fidelity Go. The program takes a very simple, straightforward approach. It's drawing on the strength of Fidelity's global research and asset management organization. The portfolios are very straightforward. There are seven different risk levels focusing on major asset classes. So there's nothing risky or speculative or complex about it. The fees are relatively low. If you have an account balance below 25,000, it's actually free. And over $25,000, you're automatically opted into a next level service where you get access to some additional tools for things like debt management, retirement planning, as well as access to a financial advisor who can provide coaching on different topics.
Hampton: So last year's top spot repeated again, what may Vanguard stand out for a second year in a row?
Denis: So Vanguard stood out because it was already significantly ahead of most of its peers in last year's ranking that we did. And this year it only improved upon most of the offerings that it provides. It splits most of its offerings between two buckets with one kind of having sub buckets, but that is Vanguard digital advisor and Vanguard personal advisor. So the former is its cheaper and digital only experience that's meant for investors with a lower account balance and who don't want to have access to a human advisor. But even with that limitation, it still has one of the most impressive breadth of services that we've seen across the entire robo-advisory industry and is very straightforward in terms of what kinds of portfolios it recommends to you. They're very thoughtful about how they come up with the sort of risk tolerance that you have for those portfolios.
And as I just mentioned, the types of advice that they can offer in that digital only wrapper are among the best in the industry. And then when you move over to personal advisory services, which has a higher investment minimum and a slightly higher fee of 30 BIPS, that's still one of the cheapest among all of the offerings, including those that don't have access to a human advisor, which personal advisor has. And it just adds upon all of that layering of excellent digital advice with access to CFP accredited advisors past that point. So again, one of the most impressive offerings that we've seen across pretty much all of the metrics that we assess.
Hampton: And when you say BIPS, you mean what?
Denis: Basis points. Sorry, that's an industry jargon for you. So 30 BIPS would be 0.3%.
Hampton: Awesome. So we talked about the best. So how about the worst. Amy, who earned that spot and why?
Arnott: Titan Invest was the only provider that ended up with a score of low. And to be fair, Titan has made some improvements. They have reduced their fees and they've added some passive investment options, which are both good things, but unfortunately the fees are still pretty high. And we do have some concerns about the investment options being overly aggressive and risky in some cases. As I mentioned, they're trying to be sort of a private wealth manager for the masses, so they're offering things like private credit and venture capital, which tend to have significantly higher costs. And in our opinion, most investors really don't need if you're an average investor just getting started. So we definitely see some room for improvement there.
Hampton: All right. Well, thank you Amy. Thank you Gabe, for your time today and explain the pros and cons of robo-advisors.
Denis: Absolutely.
Arnott: Happy to be here. Thanks for having us.
Denis: Yes.
Hampton: Thanks for checking out Investing Insights. Thanks to video producer, Daryl Lannert, and craft editor and cinematographer, David Ettinger. Subscribe to Morningstar’s YouTube channel to see new videos from our team. You can hear market trends and analyst insights from Morningstar on your Alexa devices. Say ‘Play Morningstar’. I’m Ivanna Hampton, a senior multimedia editor at Morningstar. Take care.
