Personal Finance

Returns vary widely for robo-advisors with similar risk

Francois Lenoir | Reuters

Automated investing services, known as robo-advisors, offer low-cost portfolios designed for each investor's risk tolerance — but the bespoke nature of the investments make them difficult to benchmark.

Robo-advisors are growing rapidly. Financial services research firm Cerulli Associates estimates that assets under management of robo-advisors will soar by 2,500 percent to $489 billion in 2020 from $18.7 billion in 2015. That's roughly 22 percent of the estimated $2.2 trillion independent registered investment advisors manage today.

Condor Capital, a financial advisory firm in Martinsville, New Jersey, that manages $900 million, created a novel way to compare robo-advisor performance. Condor advisors opened accounts at 13 large robo-advisors and created portfolios with a 60 percent mix of stocks and 40 percent of bonds and have been tracking returns after fees.

Fees for the most popular robo-advisors are lower than the general 1 percent annual fee many human advisors charge.

Robo fees, which are on top of expenses of the underlying investments, typically range from 0.15 percent to 0.35 percent annually. For example, Acorns levies a flat $1 monthly fee for accounts up to $5,000 and then a 0.25 percent annual fee when accounts grow beyond $5,000. Schwab Intelligent Portfolios offers its services for free, though Charles Schwab earns revenue from the underlying portfolios, which are invested in the company's exchange-traded funds, and from cash holdings deposited at Schwab's bank. Wealthfront manages the first $10,000 of a portfolio for free and then charges 0.25 percent annually.

Condor Capital's data shows a wide range of outcomes for similar portfolios at five popular robo-advisors for the first eight months of the year. (See table below.)

Condor Capital rebalanced its Wealthfront account on January 15 to maintain a 60/40 portfolio. A hypothetical Wealthfront 60/40 portfolio that was not rebalanced would have gained 6.71 percent during the first eight months of the year. That was the only account Condor Capital rebalanced during the period. The firm rebalances its robo accounts when portfolios drift 10 percent outside the desired asset allocation of 60 percent stocks and 40 percent bonds.

To be sure, Condor Capital's analysis is over an extremely short period and is not a good indicator of long-term performance, though it does illustrate how the subtle differences in a robo-advisor's portfolio construction methodologies can affect returns.

Two of the five robo-advisors outperformed two of the largest balanced mutual funds, which hold roughly a 60/40 mix of stocks and bonds. The Vanguard Balanced Index Fund returned 7.39 percent and the actively managed T. Rowe Price Capital Appreciation Fund gained 7.86 percent for the first eight months of the year. (Vanguard Balanced Index Fund charges 0.22 percent annually and T. Rowe Price Capital Appreciation Fund has a 0.70 percent annual fee.)

"Portfolios with a value bias and those with more small- and mid-cap stocks tended to do better so far this year," said Ken Schapiro, founderand president of Condor Capital.

For example, Schwab Intelligent Portfolios has roughly 37 percent of its equity portfolio invested in the stocks of small and midsize companies in the 60/40 portfolio Condor tracks. Wealthfront has only 23 percent of its equity portfolio in small- and mid-cap stocks for the account Condor follows.

The portfolio Condor Capital used is "not a mid-level risk portfolio," said Kate Wauck, a Wealthfront spokeswoman. "It's a low-level risk, so it makes sense performance is lower in this time period."

Under its risk scoring system, Wealthfront would not recommend a 60/40 portfolio for someone with a medium appetite for risk. Instead, if an investor scored a 5.0 on Wealthfront's proprietary 10-point system, they would be put into a portfolio of ETFs made up of roughly 70 percent stocks and 30 percent bonds.

"[Condor Capital's] evaluation does not take risk or taxes into consideration, which makes no sense given the entire goal of investing is to maximize your net-of-fee, after-tax, risk-adjusted return," Wauck said. "It's also a horrible overlook on our tax-loss harvesting service, which is incredibly meaningful."

Tax-loss harvesting
Tax-loss harvesting

Tax-loss harvesting

Tax-loss harvesting means selling a security at a loss and using the proceeds to buy a similar security. The tax strategy allows you to generate a federal tax deduction and maintain your market exposure. The deduction can be used to offset recognized capital gains and up to $3,000 of ordinary income a year.

Many robo-advisors offer automatic tax-loss harvesting, including Betterment, Schwab and Wealthfront.

"Surprisingly, few of our clients add their tax-loss harvesting benefit to their money-weighted returns when they compare our performance to alternatives," Wauck said.

Condor Capital's Schapiro said he is curious about how long-term returns in the tracked accounts will be affected by automatic tax-loss harvesting compared to a service like Vanguard, which conducts tax-loss harvesting for clients on a case-by-case basis at the discretion of human advisors assigned to each account.

In the short time Condor Capital has opened the accounts at the robo-advisors, Schapiro has only seen minor changes in his portfolio from automatic rebalancing.

"It seems like the most robotic part of robo-advisors is really the account opening process," he said.

Update: This story has been updated to clarify Condor Capital's methodology and that the firm rebalanced its Wealthfront account.