I have been following the rise of the robo-advisors since the first digital wealth management companies Betterment and Wealthfront emerged in the United States. I found the idea of putting my money into a diversified portfolio of low-cost ETFs, which has been algorithmically set up according to my risk appetite, very appealing and started looking for a UK-based robo-advisor. It took a while until robo-advisors launched in the UK, but eventually I came across MoneyFarm with whom I invest my money with now.
Robo-advisors are online wealth management companies that offer low-cost, fully automated, algorithm-based portfolio construction and investment management advice without the need for a human financial advisor.
In this post, I will share with you the 7 reasons why I invest using a robo-advisor and as an example, I will use the UK-based robo-advisor MoneyFarm as that is the one I personally use.
Easy To Set Up
One of the reasons why robo-advisors have managed to gain popularity so quickly is the easiness of setting up an investment account and getting started. When I set up my account with MoneyFarm I filled out an online registration form, answered their risk assessment questionnaire and within minutes my account was set up. It then took two days for my money to land on my investment account via bank transfer and I was ready to invest in my chosen portfolio.
A Diversified Portfolio According To My Risk Appetite
When you sign up with a robo-advisor you are asked a range of questions that will determine your risk classification. Your risk classification is then used to suggest portfolios to you according to your risk appetite. To construct these portfolios according to your risk levels the majority of robo-advisors use Modern Portfolio Theory (MPT). Modern Portfolio Theory is a financial theory that aims to maximize expected portfolio return given a certain amount of risk, by prudently selecting the right proportions of a range of assets within the portfolio. However, instead of picking individual stocks and bonds to construct portfolios, robo-advisors construct portfolios using ETFs (exchange traded funds). This allows them to offer a low fee structure to their clients, as they are not incurring high trading costs from picking a long list of individual securities as actively managed funds do.
For my portfolio, I chose the riskiest possible portfolio available. I am still young and I want the highest possible returns on my investments. Furthermore, I am a long-term investor and am therefore not phased by potential short-term market volatility.
One of the big selling points of robo-advisors (versus human financial advisor) are the low fees you are being charged. As robo-advisors invest in low-cost ETFs and have substantially less overhead than traditional investment management firms, they are able to offer their investment services at a much lower cost to their customer. And as high fees are a major strain on long-term investment returns robo-advisors have created a very consumer-friendly service for investors.
MoneyFarm, for example, charges 0.7% annual fee for investments up to £20,000. 0.6% annual fee for investments from £20,000 to £100,000, 0.5% for £100,000 to £500,000 and 0.4% on anything above £500,000. This makes MoneyFarm an excellent investment service for millennials, university students and even high school kids who want to get started early with their investment careers. Moreover, if you use the promotional code ‘SMSL20K’ and can get your first £20,000 managed free of charge for the first year at MoneyFarm.
On the other hand, according to the Forbes article titled ‘The Real Cost Of Owning A Mutual Fund‘ independent financial advisor Ty Bernicke concluded from his research that the average cost of owning a mutual fund is 3.17% per year! This explains why many investors are moving towards passively management investments, such as ETF portfolios, and away from actively managed mutual funds.
Passive Trumps Active Wealth Management
Passive wealth management aims to replicate an index, such as the S&P500 US Large Cap Stock Index or the MSCI World Bond Index, by buying and holding the index constituents and only adjusting the portfolio when index constituents or their index weightings change. Adversely, active fund management aims to outperform a set benchmark index by picking ‘winners’ and avoiding ‘losers’. For this stock picking service by fund managers, you are paying higher fees than you do for passively managed funds, such as ETFs and index tracker funds.
When investing in passively managed investments you save a substantial amount on fees and your investments will perform better in the long run, as the majority of actively managed funds do not actually outperform the market.
This is another big selling point as to why robo-advisors are a great service for investors. Robo-advisors invest your money into a diversified portfolio of passively managed ETFs. So, not only will your individual portfolio holdings perform better, than if you would have invested in a range of mutual funds, but also you are being charged lower overall investment fees.
I have discussed this topic in-depth in a post titled ‘Why You Need To Think Twice Before Investing In Mutual Funds’ which I published on April 25th 2016.
Benefit From The Power Of Compound Interest
One of the key reasons why I invest using a robo-advisor is that I can set up fully automated pay-ins into my diversified investment portfolio at no cost. This way I am able to benefit from ‘the power of compound interest’. Compound interest is interest you earn on interest.
Let me elaborate on that. If, for example, you invest £10,000 today and add £100 each month for 10 years at an annualised rate of return of 5%, your portfolio will be worth almost £32,000 after 10 years time. Out of the £32,000, almost £10,000 is generated by the interest on your initial invested amount and the additional monthly contributions.
Therefore, by continuously making contributions to your portfolio not only do you earn interest on the initial invested amount and on the additionally added amounts, but also on the annual returns you are generating, thereby benefiting from compound interest. I have set up automatic monthly additions into my portfolio at MoneyFarm exactly for that reason. This is how you create wealth.
“Compound interest is the eighth wonder of the world. He who understands it, earns it … he who doesn’t … pays it.” – Albert Einstein
Automatic Portfolio Rebalancing
Part of the service that robo-advisors offer is automatic portfolio rebalancing to ensure that your risk-reward ratio stays attuned to your risk appetite. In other words, should the market move aggressively against you, your portfolio will be rebalanced to minimise losses. This gives you a certain degree of peace of mind during a market downturn and prevents you from having to re-adjust your investment portfolio yourself (which would most likely incur substantial trading fees).
Set It And Forget It
And the final reasons why I invest using a robo-advisor is that it allows me to have a ‘set it and forget it’ approach to my financial markets investments. As I have previously worked in the financial industry and have a strong interest in the financial markets, I actually check my investments regularly and follow market-moving news. However, I love the concepts of automation and efficiency. Hence, placing my investment capital with a robo-advisor allows me to automate my investing process (most notably through automatic monthly pay-ins) without having to spend a substantial amount of time on it.
I highly recommend using online wealth management companies, such as MoneyFarm, if you are looking for a low-cost easy-to-use investment service that will help you generate long-term capital growth without the constant need to monitor your investments and financial markets developments.