Robo-advisors have gained in popularity over the years as investors have begun looking for professional money management without the high costs of owning mutual funds or the hassle of making your own investment decisions.
Here are five facts about robo-advisors you might not be aware of:
1. Management fees are much lower
When you buy a mutual fund, you pay what’s called a management expense ratio (MER). This annual expense covers the cost of hiring a portfolio manager and is also used for administrative fees, marketing expenses, legal costs, and taxes. The MER is usually between 1% and 2.5% a year. Although you don’t pay these expenses directly, a fund with an high annual cost can negatively affect your return.
However, a robo-advisor charges a much smaller management fee than the typical mutual fund because it invests in a basket of exchange-traded funds (ETFs). For example, let’s say you have the choice of investing $100,000 with a robo-advisor or in a mutual fund. If you go with a robo-advisor and pay an annual fee of 0.5% plus 0.25% in ETF management fees instead of a mutual fund that charges an annual fee of 2.2%, you’ll save $30,860 on fees over 10 years.
2. Leave the investment decisions to someone else
Deciding where to invest and what percentage should be held in stocks and bonds can be difficult for the average person. If you’re risk averse, you may want to hold a higher percentage of bonds. Also, you should rebalance your portfolio annually. For instance, if stocks do well in a given year, you might end up with a higher allocation to stocks than bonds. And you should invest in the American, European, Asian, and other world markets, not just in Canadian stocks.
A robo-advisor makes the decisions about asset allocation for you based on your investment objectives and risk profile. It will also rebalance your portfolio for you. And if your financial needs change, your portfolio can be modified.
3. Minimum investments vary
If you want to invest in individual stocks, you need to do a lot of research first before buying each one. To achieve true diversification, you’ll need to have at least 10 to 20 individual stocks all in different sectors. The cost and time to create such a portfolio can vary. The minimum you’ll need to build a portfolio like that can be as much as $50,000. If you buy individual ETFs, the minimum investment won’t be as much but the cost of buying and selling ETFs can eat into your returns initially.
Luckily, the minimum amount you need to invest with a robo-advisor is much smaller. Some start as low as a $1 while others are just $5,000.
4. Get tax-loss harvesting
If you have a non-registered (taxable) account, you have to pay tax on the income earned and capital gains received. There are ways to minimize the amount of tax you pay on gains and income by realizing a loss, which can help you accumulate wealth faster. For novice investors, tax-loss harvesting might be a somewhat difficult exercise. But this is something some robo-advisors can do for you, saving you time and money.
5. Not all are available across Canada
The availability of robo-advisors varies depending upon the province or territory you live in. They’re usually registered in the provinces with the largest populations, such as Ontario, Quebec, and British Columbia. But if you’re in a small province or a territory, there’s a chance you can’t open an account with the robo-advisor of your choice.