I’m on a quest to find the best retirement plan to roll over my old 401(k). Since millions of other people are in this same boat, and don’t know where to turn for sound advice, I figured I would conduct the most thorough research I could — publicly — then put my money where my mouth is. At the end of my research I will literally roll over my old 401(k) worth approximately $85,000 to the best plan and company I can find!
A Bit of Background
I’m 33, have two kids under the age of three, and a wife who also has a full-time job. Because my plate is full both at home and at work, I have been desperately searching for the easiest and cheapest way to manage my passive long-term stock and bond investments. I want no hassles and no extra hidden costs.
After leaving a previous job six years ago, the money in my 401(k) account has just been sitting with my old employer collecting dust. I’ve never met with a representative of the 401(k) plan to discuss my options or my optimal asset allocation to cover the next 30 years until I need the money in retirement. No one contacts me, and I don’t know who I would even contact if I had a question. I am, like millions of other 401(k) holders, adrift with no set direction.
I know from my days working in the finance industry that the less I touch my plan, the better. Overthinking my long-term assets has usually done more harm than good. It also needs to be cheap because, once I have a basic strategy in place, there really isn’t any required maintenance to the plan for a long, long time.
Staking My Retirement on Online Financial Advisers
In my research for the best retirement plans, I stumbled upon online financial advisers (OFA) like Betterment, Wealthfront, FutureAdvisor, Personal Capital and others. Even online discount brokers like E*Trade: Build your own portfolio are getting in the mix. These services use software algorithms to simplify passive investing and automate many of the value-added tasks we pay money managers a pretty penny to execute. This creates easy plans you can follow at the cheapest possible price.
Since looking into these services, I’ve become so convinced that this is the wave of the future that I’m staking my retirement on it. This is the first in a series of posts where I will investigate how these automated online retirement services are driving down costs for Main Street investors.
At the end of this series, I will literally roll over my $85,000 401(k) to one of the online services I feel is the best fit for me!
Why? Because I believe the current financial services compensation model is broken. The financial services model as it exists today is not aligned with your average Main Street investor. The current system utilizes high-cost funds and high-cost management account fees that add complexity and fall short on value. The financial services industry model is ripe for disruption and competition.
In the posts to follow, I will discuss how the current financial fee structure is broken, compare different OFA options, and discuss why you should think about using these services in the future.
Passive vs. Active Investing
According to Investopedia, passive investing is: “An investment strategy involving limited ongoing buying and selling actions. Passive investors will purchase investments with the intention of long-term appreciation and limited maintenance.”
For most people, passive investing comprises three main actions:
- Buy and hold for the long term
- Diversified asset allocation among a variety of asset classes
- Rebalancing and re-evaluation
Active management, in contrast, involves frequent trading to try and maximize return and beat a benchmark like the S&P 500. Most mutual funds as they exist today are actively managed. For regular investors, this option is expensive and rarely returns above a passive benchmark. Virtually every study ever done has shown there is no correlation between high fees for active management and high returns. The additional transactions add to your overall costs, and any additional return above a benchmark is typically washed out by the increased fees on average.
The argument for passive investing isn’t new. Burt Malkiel championed this in A Random Walk Down Wall Street as early as 1973. There is no correlation between fees and high returns, so why should you pay them? The easiest and simplest way to invest is passively through low-cost vehicles. This not only saves you money, but also saves you lots of time and headaches.
Problems With the Current Active Financial Incentive Model
I briefly worked in the investment management business straight out of college, but I quickly became aware of the broken incentive structure above. There are two main issues.
Problem #1: Fee Structure
According to Morningstar, a rating service, the average managed stock fund charges 1.33% per year in management fees, but also, as studies have shown, rarely returns more than the market averages. In addition to this fee, you may pay a “sales commission” of close to 5% to your financial adviser. So you start out 5% in the hole.
On the other hand, low-cost ETFs that hold a basket of stocks that simply replicate the performance of the broader market have drastically lower fees. For example, the average ETF expense ratio at Vanguard, a leader in low-fee funds, is 0.14% with no sales fee.
This Atlantic article does a great job of laying out how the fee difference can add up to six figures over a lifetime of savings. In their example, which uses slightly different numbers than the ones I provided, this could be a difference of $257,000!
Clearly, there is a problem with how the typical investor pays for financial services and the actual value delivered. More specifically:
If passive investing is the best strategy for the majority of long-term investors, the big question is: Shouldn’t investing then be as cheap as possible? The answer is, unequivocally, yes.
Problem #2: Incentive Structure Is Not Aligned
A typical financial adviser is paid for gathering assets, NOT for generating return for you.
When your holdings go up in value, your adviser earns a miniscule extra amount, but when he brings on new money to manage from someone else, he gets paid significantly more. The risk to him when your assets lose value is small.
Call me naive, but when I learned that I could make more money by pursuing new clients to the detriment of my current clients, I quit so I can trade financial instruments on my own in Chicago. By trading, my interests and my clients’ interests were aligned – I didn’t get paid if I lost someone money. Here, I could still be connected to the markets, and my income was a direct result of the return I generated for the company. I would do well if I made money, but if I didn’t then I’d be fired quickly. This is completely at odds with the current financial services model.
A good financial adviser, and there are scores of them out there, takes the time to work you through asset allocation decisions and can get you in the right investment vehicles. These services are well worth a price. I am not arguing that financial advisers shouldn’t be paid. But herein lies the problem. Because financial advisers get paid more for getting more people to place their assets with them, they are incentivized to get many, many clients to whom they cannot allocate enough time. Once your main assets are uncovered, there is actually an incentive to spend the least amount of time with you as possible.
If most of the value a financial adviser creates is with education and account selection, then why should commission fees be tied to how much money you have with the adviser?
How Online Financial Advisers Work for You
At the heart of online financial advising is the basic idea that you should keep more of your money. By using low-cost ETFs, and by using software to “automate” tasks, like rebalancing, that your human financial adviser performs, the cost associated with managing your account is driven way, way down.
An Example Using Betterment
For example, Betterment is an online financial adviser that is growing very quickly. According to recent numbers, ETF expense ratios inside a Betterment portfolio range between 0.05% and 0.36%. So, on average, 0.155% of your assets are going to cover the expenses of the fund rather than 1.33% which, according to Morningstar, is the average for managed mutual funds. That figure is in addition to whatever fee the OFA charges to manage your funds.
Now, you could simply open an account at almost any online discount broker and enjoy these modest expense ratios if you 1) know what ETFs you should choose, 2) know how to diversify, 3) know how to effectively rebalance your portfolio, and 4) understand tax loss harvesting.
However, if you do not know how to do any of these four things, here is where online financial advisers such as Wealthfront and others truly shine. These services can:
- Educate you on your investment options
- Guide you to the optimal portfolio given your risk tolerance
- Automatically rebalance your portfolio to keep your optimal mix of assets
- Automatically take strategic losses that can offset your taxable income
On a portfolio of my size, for these added services, which are transparent and aligned with my interests and goals, Betterment charges a 0.25% fee per year.
Recap the OFA math
According to CNN, the average 401(k) balance in the U.S. is $89,000. Using this figure and other data uncovered in this post, we can see the difference in cost from just one year of investing.
Remember, OFAs charge a stated rate, and you are paying fees inside the ETF also. Managed funds have this issue as well, but those fees are significantly higher. So the comparison should look like this:
|Combined Fees||Applied Balance||Total Cost|
|Avg. Managed Fund||1.33%||$89,000||$1,183.70|
In the combined fees column I am adding Betterment’s 0.25% fee to the average ETF fee that I calculated earlier of 0.155%.
Now ask yourself: How often do I talk to my 401(k) adviser? Is it enough to justify an extra $778.75 per year? I think not.
Wealthfront, Betterment, Future Advisor: The Online Financial Adviser Landscape
At this point, I hope I’ve made a strong case for you to at least consider how online financial advisers (OFAs) can help you keep more of your money and, quite honestly, more of your time too. In the next few weeks, I will be deciding which OFA to roll over my $85,000 401(k) into. But first, we need to understand the OFA landscape and what our options are. Here is how I see the landscape segmented out. I will give an in-depth review of each service in the following weeks before making my decision.
True Automated Accounts
In order for an online financial adviser to be “truly” automated, the service must be able to hold and manage your assets. This means you create an account with the service, place your money there, and the service enacts several programs to manage your account. This includes ETF selection for diversification, portfolio rebalancing, and tax loss harvesting. With this type of service, you do not have to do anything with your account if you don’t want to.
For my research, the top three services I will investigate are:
Wealthfront. I am most familiar with this service mainly because they are the quickest advisory service EVER to reach $1 billion in assets under management. This includes household names like E*Trade, Charles Schwab, Merrill Lynch, and other well-known financial firms. Wealthfront is also working with some high-profile clients like NFL teams.
Fee structure: 0.25%. First $10,000 is managed for free.
Here is my Wealthfront review.
Betterment. Like Wealthfront, Betterment uses modern portfolio theory to guide its asset allocation recommendations. They also have automated services that balance your portfolio and maximize your tax efficiency. The main difference on the surface seems to be their fee structure.
Fee structure: Three tiers based on account balance: 0.35% for less than $10,000 with a $100 per month direct deposit; 0.25% over $10,000; and 0.15% over $100,000.
This means that as your balance grows, you have the chance to pay less in percentage fees – very appealing.
Here is my Betterment review.
FutureAdvisor. Right now, I know less about this service. From their site, it looks like they offer much of the same in this category, mainly rebalancing and tax efficiency. However, the fees are double at 0.5%. Hopefully, I’ll uncover some hidden gems that make this service worth the higher price! I can’t wait to find out.
Fee Structure: 0.5% of assets.
Do-it-yourself services are software that make recommendations based on many of the same principles as the truly automated services, but you have to implement the trades yourself with DIY. There are a few ways to do this but, for a general idea, imagine you have your own brokerage account and you use a separate software program that reads what your asset allocation is and makes recommendations. You then take the time to implement them or ignore them.
E*Trade: Build your own portfolio. E*Trade’s approach gives you the choice as to how much help and control you want with your portfolio. It’s not quite a hybrid because I don’t think they offer human contact, but you can choose to 1) build your own portfolio, 2) choose an E*Trade portfolio, or 3) choose to have E*Trade actively manage your account.
Fee structure: You pay E*Trade’s low commissions on trades within the portfolio.
Marketriders. Marketriders seems interesting because it can work with a variety of brokerage accounts. It recommends low-cost ETFs just like the fully automated ones, but it can work with any brokerage account.
Fee structure: 0.2% of assets.
SigFig. SigFig is similar to Marketriders in terms of recommending a low-cost, tax-efficient portfolio and managing it for you but, as far as I can tell, it only works with TD Ameritrade, Schwab, or Fidelity.
Fee structure: $10/month with no commissions or other trading fees.
Hybrid Automation With Personal Contact
Hybrid services might offer the best of both worlds: low-cost automation, but with the ability to contact a human adviser to answer questions. We shall see.
Personal Capital. Personal Capital seems like “Mint.com for rich people” because it aggregates and displays your financial information much like Mint does with your bank account and spending info. I believe this is a free service. You can then analyze your investments and have Personal Capital manage them for you. Their fees are higher and they seem to cater to high net-worth individuals, but they do offer human interaction.
This could be a good choice if it addresses some of the shortcomings that I experience with Mint.com — but those fees!
Fee structure: 0.89% up to the first $1 million; 0.79% up to the first $3 million; 0.69% on the next $2 million; 0.59% on the next $5 million; and 0.49% on assets over $10 million.
Vanguard Personal Advisor Service. Vanguard is the leader in low-cost ETF investing. In fact, their funds are often used by fully automated services like Wealthfront. Vanguard’s Personal Advisor Service uses their low-cost funds to save you money and offers simple tools to figure out your goals and optimal asset mix. You can then partner with an adviser to plan for life changes or to change your allocations.
Fee structure: 0.3% of assets.
The Online Financial Advisor Challenge
I’m very excited to dig into all of these companies to see which one fits best with my long-term objectives. I view myself as a pretty regular guy who has similar work, family, savings, and spending challenges as a good swath of the country. I’m sick of paying too much for things that don’t deliver on value, so I can’t wait to see how these value-added services stack up. My gut tells me this is the future of long-term investing.
We’ll see who gets to manage my old 401(k) money. Let the games begin!