As an author that hasn’t hit it big (as in, if I had to live off of my author earnings, I would be homeless), I make my living as a journalist, a photographer, and from other side hustles. Some day I would like to write my novels and short stories as my primary occupation, but part of that planning involves saving enough money that I don’t need to earn a full-time, 40-hour-per-week living.
So, with that in mind, my plan was to buy a house so that once it’s paid off, I have cheap rent. Or, I move and it becomes a rental property and earns me income. And part II of the plan is to invest as much of my income as I can manage so one day I can live off of the interest. Then I can focus on my novels.
As most folks in the FIRE Community know (Financial Independence, Retire Early for those not in the know), index funds are typically the gold standard. They’re usually low cost, low-yield, but generally consistent over time. Unlike investing in individual stocks, which can tank, funds are managed so that, overall, they tend to increase in value over time. (There are exceptions, of course – everything tanked in 2007-08, but the market eventually comes back.) The assumption with index funds is that you’re generally playing the market overall, and if there’s one force that is going to make sure it always stays ahead. Individual stocks rise and fall, but the market always continues forward.
But, this is the modern age. Why have a human at the helm when an algorithm can manage funds, using best practices and without the human element of fear, ego or pride?
It’s with that idea that I went all in on California-based Wealthfront, an electronically managed fund that current manages $8.2 billion in funds. Betterment, Wealthfront’s New York counterpart, manages $10 billion. The philosophy, according to Wealthfront’s website: “Picking stocks and chasing market fluctuations may be exciting. But when it comes to long-term investing, you can’t expect to outperform the market.”
And you don’t really need to. According to SPIVA research, 93 percent of actively managed U.S. equity funds underperformed their benchmark in 2016. (That benchmark matches their 3-year returns against the S&P 1500.)
So that’s data from Wealthfront’s website (I reviewed the original source document from SPIVA and it checks out) but it’s not the first time I had heard that statistic. According to Daniel Kahneman in his book, Thinking, Fast and Slow, his research found that there was no correlation between performance and investment bankers. In other words, the ones who did well, did so purely by chance, and they were just as likely to lose the next year. Interestingly enough, when he presented this research to investment firm executives, they were only surprised to learn there was zero correlation; before Kahneman presented the research they already thought the correlation was pretty low.
One of the things going for Wealthfront is that it has a very diverse set of offerings. US stocks, foreign stocks, emerging markets, dividend stocks, natural resources and even municipal bonds, with a little cash thrown in for stability. That goes beyond even most index funds I’ve found.
For this, they charge one flat fee of .25 percent of your account. The first $10,000 managed is free.
Starting with Wealthfront
So that brings us to Wealthfront. Once I had saved for the down payment on my house, my next step was to start investing. I read up on Wealthfront and didn’t find any red flags at the time, so I thought, why not?
I invested my first $500 with a resolve. Let’s see how this pans out.
At first, it didn’t. My $500 quickly turned into $450. Why? I invested only a handful of days before the Brexit vote rocked the financial world and stocks took a nosedive. I was angry, suspicious, and leery. But, I remembered a line from Mr. Money Mustache: When the markets dive, that just means stocks are on sale. (A paraphrased quote.) So I stayed the course, and continued to invest every time I had another $500 ready (I should note this is my arbitrary number — you have to start with $500 but beyond that, I’m not sure there is a minimum. (Wealthfront doesn’t list any.)
I decided not to post specific dollar amounts, since I used my real name on this blog (or close to it — BC is my pseudonym) but I will say that since my first investment in 2016 I have earned an all-time, money-weighted return of 25 percent. In 2017 alone, I have gained at 21.5 percent return. I’m still in the positive for 2018 so far, despite the nosedive the market has taken. From an observational perspective, it seems like Wealthfront’s algorithms manage to capitalize on big market gains and are able to soften (but not eliminate, of course) market dips. It rides the bear and tames the bull, from what I can tell.
To start with, recent news: Both Wealthfront and its competitor, Betterment, went dark during the stock market “bloodbath” with record down losses. When your money is invested online, it can muddy the waters of confidence for investors, when the platform seems to disappear. For millennials and Gen Xers (me being in the latter category), that might be par for the course when dealing with online investing, but it’s sure to give folks in later generations a bit of pause. But should it? In long-term investing, one shouldn’t be rushing to sell or buy. You’re playing the long game anyway.
A white paper from the Massachusetts Securities Division criticizes robo-advisers, essentially saying they don’t offer a personalized service such as a human advisor is required by law to provide. A human advisor by law is required to hold its clients best interests at the forefront.
But what does that mean, and who enforces that? The questions that raises, if the market by its nature is unpredictable, how is a securities commission supposed to prosecute an advisor who steers you toward an investment that pays them a higher dividend?
It is true that a robo-advisor is far less personalized than a real life human (assuming of course you have a good advisor with your best interest in mind, and those people certainly exist). But I’m not sure that’s what these funds are really meant to replace. To me, funds like Wealthfront are more of a replacement for an index fund, and in Wealthfront’s case at least, a more diversified version of it.
For most of those in the FIRE community, we already have a pretty good handle on our finances and have a do-it-yourself attitude. And also, most human financial advisors have traditional mindsets of working until retirement age. They calculate your retirement needs based on income, not on spending. For those in the FIRE realm, our spending is far lower than our incomes, because we live frugally.
In another paper, Robo-advisors: A Closer Look by Melanie Fein the author levels many of the same criticisms — that robo-advisors don’t offer the same level of advice that a human can. It also characterizes robo-advisors as “gimmicky and overly simplistic.” Robo-advisors miss key, relevant details about a person’s financial picture: Does the investor have dependents, what is the investor’s contribution and withdrawal schedule, monthly expenses, tax situation, etc. The SEC and the Financial Industry Regulatory Authority issued a caution in May 2015 essentially issuing the same caution: That its financial advice may be incomplete or based on false assumptions.
And, it’s important to note, a review of the contract agreements of a number of robo-adivsors by the paper’s author reveals the following:
Do not provide personal investment advice
- Are not free from conflicts of interest
- Do not necessarily minimize costs
- Do not act in the best interest of the client
- Do not meet the standard of care for fiduciary investments
Are not designed for ERISA retirement accounts and would not meet the DOL’s proposed “best interest” contract exemption.
It’s certainly true that a person who needs that advice likely is better served by dealing with a human advisor. However, the same criticism could be leveled against an index fund. I don’t think that’s the purpose of a company such as Wealthfront. For us in the FIRE community, we already have a handle on our finances. We know our monthly expenses and everything that leads to those expenses. We are well aware of the 4 percent withdrawal rule, and its potential pitfalls.
But in all fairness, Wealthfront does see itself as an investment advisor. This from the company’s website: “At Wealthfront we believe that everyone deserves access to sophisticated financial advice, without the hassle or the high fees.” For those outside of the FIRE community who really need complete picture financial advice, this statement is probably misleading.
And one criticism from the paper that is 100 percent fair: So far, robo-advisors have only been tested in a bull market. They “are untested in how they would perform in a downturn,” the paper says. I supposed we might be about to find out. But I have a hard time seeing them performing worse than an index fund, since that’s essentially what they are. My investments have dipped with the market, of course; but I’m still up quite a bit from my principle.
As for myself, I consider Wealthfront a means of investing only. I am the one planning out my bigger financial picture. I wouldn’t trust a computer to make this plan, and frankly, I wouldn’t trust another human to do so either. Talking about my plans with anyone always requires me to spend an inordinate amount of time breaking down assumptions until they can finally understand my long term plans. Why should I pay a financial advisor good money to explain the principles of FIRE and frugal living to them? I can just do it.
What do those in the FIRE community have to say about it? J Money, of Budgets are Sexy, says robo-advisors are a hot topic in the community, and mostly (though not 100 percent) positive. In J Money’s own words:
I’m ALL for ways that get people excited and *started* with investing, and places like Wealthfront or Betterment or WealthSimple do exactly that for people. They may not be for the more seasoned hands-on investors, but for the majority of the population? Hell yeah! Most people are too afraid to start investing and have no idea where to start – these guys not only point them in the right direction, but then actually open the account for them and invest the money too — a nice 1-2 punch. If you have no idea what you’re doing with investing and/or haven’t even tried yet, I highly advice checking out some robo-advisors and just getting the ball moving.
For me, Weathfront, and probably Betterment too (again, I only need one and liked what I had read about Wealthfront, oddly enough I think in an article critical of robo-advisors) works for what I need it for. I have foregone most of the unnecessary extras. I didn’t put my home equity in, it doesn’t know how much I make, and it has no idea I am a FIRE enthusiast. Like an index fund, it just sits there and helps my money earn me more money toward my goals. Exactly what I want from it.
Disclosure: I made it clear in the article but I have no affiliation with Wealthfront other than that I personally use the service. There are no affiliate links anywhere in this article. The link to Thinking, Fast and Slow, is an affiliate one. It’s a fascinating book and I recommend reading it.