When I first heard about robo-advisors, I dismissed them. Who needs an AI to do some basic trading and build an ETF portfolio? Many of us DIY investors may still feel this way. However, in the past few years, robo-advisors have significantly improved their algorithms and simplified some complex tasks. But what’s actually better a robo-advisor or DIY portfolio?
Robo-advisors make it incredibly easy to manage complex portfolios with the click of a button, on the other hand, a DIY portfolio gives you more flexibility and potentially higher returns, due to no additional fees.
Thus, it depends on how much time, effort, and learning you are willing to put into your investing. If you enjoy learning about and analyzing investment products, then go ahead and DIY. However, if investing is more a means to an end for your, robo-advisors get the job done.
In this article, we’ll go through what a robo-advisor actually and what we mean by DIY portfolio. Then, we’ll compare some of the key differences and pros and cons of each. Factors include goals, time, flexibility, fees, and – of course – returns.
I’ll conclude by explaining a combinatory approach and integration of robo-advisors and DIY that may suit investors pursuing financial freedom.
What is a robo-advisor?
A robo-advisor is a broker that uses algorithms to manage portfolios and execute trades. The broker usually offers their clients a visually appealing, easy-to-use platform, on which to determine their broad investing goals.
Frequently, the robo-advisor will then suggest different portfolio strategies according to the aforementioned investing goals. The choices offered tend to vary by risk and will typically include portfolios with a varying exposure to bond funds.
Once the portfolio strategy is selected, the robo-advisor does all the subsequent work. It will place the necessary trades to achieve the desired portfolio allocation, auto-rebalance your portfolio to make sure these allocations remain, invest in fractional shares, and conduct tax-loss harvesting.
All this happens in the background unbeknownst to the end-user. This is why these types of brokers are called robo-advisors. All actions are performed by an algorithm; no human involvement is necessary.
What is a DIY portfolio?
A DIY portfolio is a portfolio that is completely managed by you. You decide your overall investing goals, the corresponding portfolio strategy, and even select the individual funds that make up your portfolio.
Additionally, you also perform all portfolio maintenance tasks such as rebalancing when your allocations get out of hand, and doing tax-loss harvesting when necessary. You also execute each trade individually and thus remain in full control of your investments.
Robo-advisor or DIY Portfolio
Both strategies obviously have their pros and cons. But which of the two is right for you? With the help of the criteria below, I will try to explain when a robo-advisor or a DIY portfolio might be the right strategy.
Let’s start by figuring out your investment goal. What are you investing for? What are you hoping to achieve?
To give you an example, I’ll tell you mine: I’m investing for financial freedom. That means that my primary goal is to earn enough money through investing to sustain a moderate lifestyle without any other income.
If investing is a means to an end, like it is for me, robo-advisors have a lot to offer. If investing is your job or hobby, using a robo-advisor will leave you deeply unsatisfied and a DIY approach is way more suitable for you.
Another big factor that will determine if robo-advisors or DIY portfolios are right for you is the spare time you have available to dedicate to investing.
Obviously, the less time you have, the less you will be inclined to spend that little free you’ve got on analyzing balance sheets. Thus, robo-advisors will be of exponential value to you. As your spare time increases you will be able to complete small portfolio tasks by yourself, perhaps eliminating the need for a robo-advisor.
One of the greatest arguments for a DIY portfolio has long been flexibility. With a DIY portfolio you get to decide exactly which securities to buy and exactly when to do it. No robo-advisor can you give you that much control.
However, even this is changing. robo-advisors are now giving their clients more options than ever to choose from. Just look at the number of investment options Wealthfront currently offers:
With the wealth of options available, it’s hard to argue that robo-advisors lack any sort of real flexibility. Probably for around 95% of investors, robo-advisors provide plenty of flexibility and options to choose from; sometimes perhaps even too many.
One of the most prominent differences between robo-advisors and DIY portfolios are the corresponding fees. While it is true that robo-advisors will typically cost you more upfront there are some key facts I would like to highlight:
- DIY portfolios incur fees as well
- The additional fees you pay for a robo-advisor might pay off
Let me elaborate.
DIY portfolios obviously don’t incur any portfolio management fees since you are the one managing it, but you might be subject to fees from your broker when buying or selling securities. Sure, there are brokers out there like Robinhood, which don’t charge any fees at all for buying or selling but this has its downsides as well.
- Read: Why Robinhood Is Bad
Secondly, almost all funds charge fees – even ETFs. But as you – the clever reader – probably already know, there are also some fee-free funds now available from Fidelity. However, these funds are not in themselves sustainable and can only survive as loss-leaders (Vanguard may still have the upper and here).
- Read: Why Vanguard Is The Best
Ok, now on to the next point. Why would the fees you pay for robo-advisors perhaps be a wise financial decision?
Because of the taxes they might save you in the long-term. Doing tax-loss harvesting manually is extremely difficult. Or rather doing tax-loss harvesting the right way at optimal times is extremely difficult and time-consuming.
Thus, the more your portfolio grows and the more you plan to cash out, the more important it is to have an efficient tax-loss harvesting strategy in place. If not, your tax burden might significantly reduce your returns.
Since your overall returns will depend more on the portfolio strategy you employ rather than the fact that you are using a robo-advisor or DIY portfolio, it’s impossible to make any general statement about returns.
But from the above we can conclude the following:
Robo-advisors charge fees, DIY portfolios don’t. Thus, it seems entirely possible that a DIY portfolio may yield a higher return over the long-term.
However, it is also likely that you are not as efficient at tax-loss harvesting as a computer algorithm (prove me wrong). Which would mean that, in the end, the extra fees may actually pay off.
But why take that risk?
Robo-Advisor or DIY: Why not both?
Let me point out a method that gives you the best of both worlds – efficiency & flexibility – without charging any fees. We should use robo-advisors to the degree of automation and efficiency we see fit for your portfolio. Not more, not less.
This year I switched from my traditional Vanguard account to M1 Finance and I couldn’t be more pleased with the change. Don’t get me wrong: Vanguard is a fantastic place to invest and I still use their financial products.
However, doing so from a semi-automated robo-broker like M1 Finance not only lets me invest more efficiently but retains my flexibility and control to manage my portfolio when and however I see fit.
In short: I can auto-invest in fractional shares, re-balance my portfolio with a click and still have total control over every single fund I invest in. If you’d like to give them a try and see why I’m a fan click here.
There are likely just as many pros as cons to using a robo-advisor vs. DIY’ing your portfolio. In the end, it will depend on your personal style of investing and how much time you have available.
For me, the sweet spot is that where I still get the maximum benefits that robo-advisors offer while remaining in full control of my investments.
For all that robo-advisors can do, I think it is important if not necessary for us to educate ourselves about out financial situation and goals in order to achieve financial freedom. Only when we have enough information available to us, we will be able to make wise financial decisions. There ain’t no robo-advisor for that (yet).
Over the past years, I have discovered several tools and products that have helped me tremendously on my path to financial freedom:
P.S.: The links below are affiliate links, which means I receive a small commission at no extra cost to you when you sign up for one of the services. Thank you for your support!
1) Take a look at M1 Finance, my favorite broker. I love how easy it is to invest and maintain my portfolio with them. I can set up automatic transfers, rebalance my portfolio with one click and even borrow up to 35% of my assets at super low interest rates!
2) Fundrise is by far the best way I've found to invest in Real Estate. You can diversify your portfolio by investing in their eREITs or even allocate capital to individual properties (without the hassle of managing tenants!).
3) If you are interested in crypto, check out Coinbase. I've started allocating a small amount of assets to the growing crypto space and Coinbase has just been a breeze to use. Once you register, make sure to also open a Coinbase Pro account to buy crypto at the lowest fees on the market (just 0.1%!).