Investing In ETFs: Do-It-Yourself Or Use A Robo-Advisor?
This article was contributed to us by Michele Ferrario, Co-Founder and CEO, StashAway.
Exchange-traded Funds (ETFs) are getting increasingly popular in Southeast Asia, and so are robo-advisors. What’s the best way to invest through ETFs? Should you do it with a robo-advisor? Here are a few things you need to make sure you or your robo-advisor are doing.
Investing In A Diversified Portfolio With The Right Asset Allocation
Most robo-advisors today use various asset allocation strategies to manage portfolios, because asset allocation has been proven to account for the vast majority of portfolio returns. Investors should pay attention to the different asset allocation strategies, as differences can be significant. What the robo-advisors’ asset allocation strategies have in common is that they save you time in deciding which ETFs to diversify your portfolio. That way, you don’t have to try to figure out what percentage of a portfolio should be in Tech Stocks and Long-Term Government Bonds, or Short-Term Government Bonds, and European Equities and Gold.
Consistently Maintaining A Portfolio
Investing in a well-constructed portfolio does not end with the initial asset allocation. Portfolios need to be rebalanced over time to account for regular fluctuations in the market. Most robo-advisors rebalance investors’ portfolios automatically as part of their fees, to ensure that the target asset allocation is maintained over time. And sometimes, a portfolio’s asset allocation needs to be reconstructed to account for changes to an asset class’ valuation or economic conditions.
Robo-advisors help in being systematic, and can avoid the classic behavioural bias that push retail investors to buy more from excitement when the markets are growing, and sell out of fear when the markets have dropped, which is the opposite of the right strategy. Automation, which is at the heart of robo-advisors, minimizes or removes the room for error that can come with rebalancing and portfolio reconstruction. This automation ultimately increases the probability of higher long-term returns.
A DIY strategy requires investors to make asset allocation and rebalancing decisions independently, or to “copying” portfolios from someone else. DIY investors can rebalance autonomously with a simplistic periodic rebalancing (e.g., once a quarter), but would need to monitor their portfolios very closely.
Reducing The Total Cost Of Investing
The following table summarizes the fees that investors pay investing DIY versus through a robo-advisor.
The difference between the brokerage trading fee and the robo-advisors’ management fees depends on the size and frequency of the investments. An investor deploying $1,000/month in 8 ETFs and paying a minimum trading fee of $10/trade will pay $80/month, or 8%, upfront in brokerage trading fees monthly. These fees total $2,880 during the first 3 years of the strategy. In contrast, the same investor deploying $1,000/month in 8 ETFs with a robo-advisor and paying a 1% management fee will pay $549 fees in the first 3 years, and will take 7 years to build a portfolio large enough to start paying $80/month fees.
On top of the brokerage and management fees, there are often FX conversion fees. Most robo-advisors are able to reduce the FX spread and the intra-day volatility and bid-ask spread thanks to their scale (e.g. better buying power on FX spread) and their technology (e.g. optimized execution of orders through automated algorithms). The impact of these differences can be significant: for example DIY investors pay 0.4%-0.6% in FX conversion fees, while some robo-advisors have negotiated as low as 0.1% FX conversion fees.
In summary, the absolute fees themselves will likely be a little higher with a robo-advisor, but the difference in the higher returns with a robo-advisor’s automation, precision, and asset allocation strategy would still earn you more in the long term.
Should You Invest With A Robo-Advisor?
Both ETFs and robo-advisors are great developments that are revolutionizing the way people build their wealth. There’s no clear-cut answer on whether it is best to invest in DIY or through a robo-advisor. Robo-advisors provide a simple-to-use, cost-effective, and intelligent way of investing, and most people will probably benefit from being hands-off in their own investment management. If you enjoy managing your own portfolios, just please be sure to force yourself to be extremely disciplined by monitoring your investments closely, maintaining a regular frequency of investments through dollar-cost-averaging, and maintaining the right diversification and asset allocation of your portfolios.
DollarsAndSense Editor’s Note:
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