FREE NEWSLETTER
ALGORITHMS, THOSE fancy computer calculations that can help you find the closest slice of pizza, are upending entire industries, including money management: They have given rise to a new generation of robo-advisors such as Wealthfront—the company I use to manage my investments.
Why do I trust a computer with my savings? The truth is, humans aren’t very good at choosing investments. Exchange traded funds (ETFs)—low-cost passive funds that own a broad collection of stocks—have emerged as an attractive alternative to actively managed mutual funds. Index funds are eating the financial world, with the savings being passed along to everyday investors.
Wealthfront systematically evaluates the landscape of over 1,400 ETFs and spreads my money across nine primary recommendations, based on an assessment of my investment goals and risk tolerance. This is the sort of task algorithms are perfect for.
Wealthfront also takes care of three basic account maintenance activities. The first is rebalancing, which is the buying and selling of funds to maintain a desired balance between different asset classes. Let’s say your optimal balance is 60% stocks and 40% bonds. Because different investments will grow at different rates, over time your account’s ratio will get out of whack. Wealthfront takes care of the buying and selling of assets to keep an optimal balance.
Second, Wealthfront automatically reinvests dividends. This makes sure you’re maximizing the long-term growth of your account. Finally, Wealthfront takes care of tax-loss harvesting on all taxable investment accounts. When you own different assets, some will go up and some will go down. Tax-loss harvesting is the process of writing off investment losses to minimize your tax bill and maximize your earnings. It’s a strategy—previously reserved for millionaire investors—that Wealthfront has democratized. Just send the 1099 Wealthfront generates to your tax advisor and you’re set.
Of course, these investment goodies aren’t free. Wealthfront charges a flat 0.25% fee per year. That is significantly less than the average human financial advisor, who typically charges about 1% a year. Your first $10,000 is managed for free, and you can get an additional $5,000 managed for free for every friend you invite to the platform. It’s an effective “growth hack.” I’ve invited two friends, and have up to $20,000 managed for free.
As much as I’m a fan of Wealthfront, especially because of the free management bonuses, it might not be the best solution for me once my investments reach a certain size. At the moment, I’m happy paying 0.25% to not spend time managing my account. Once my account is larger, that fee could mean thousands of dollars per year—and it would be worth it to spend my time manually rebalancing my account and reinvesting dividends. But until then, I’m sticking with the algorithm.
Steven Aguiar is the founder of BlueWing, a B2B digital marketing agency. He majored in Economics and Hispanic Studies at Brown, and is a big fan of compounding interest.
Want to receive our weekly newsletter? Sign up now. How about our daily alert about the site's latest posts? Join the list.
I suggest you take a look at M1 Finance’s platform. Here is an excerpt from a review:
“Since late 2017, M1 has charged zero fees. There are no commissions or mark-ups either, as long as you open a taxable account with a minimum of $100 or a retirement account with a minimum of $500. For that low, low price, you have access to thousands of individual stocks and ETFs to select yourself or take on as part of a prepackaged portfolio based on your risk preference, investment horizon, or personal outlook toward a particular sector or type of investing (for instance, socially responsible investing).
In case you’re wondering, M1 makes its money through a combination of payments for directed order flow, cash management, and lending securities to short-sellers.”
If you know which ETFs and/or stocks you want to include in a portfolio, and target percentage allocations for each, M1 Finance’s platform seems to offer everything you discuss at no cost except automated tax-loss harvesting.
Opportunities to tax-loss harvest should become less and less frequent once you’ve harvested major losses during market declines and replaced the harvested positions with similar but not substantially identical positions. For example, harvest losses in a S&P 500 ETF and replace with a Russell 1000 ETF. If Russell 1000 ETF declines, harvest its losses and revert to the S&P 500 ETF after 31 days or revert to S&P 500 ETF after 31 days if that is favored over Russell 1000 ETF and reversion would not result in a realized gain.
Each time you tax-loss harvest you will lower your cost basis for the position and its replacement, making it less likely over time that the position will result in an enough decline for a tax-loss harvest opportunity.
And, realize that tax-loss harvesting is only deferring taxes, not actually saving taxes, except if heirs inherit positions at stepped-up basis. In other words, if you ever want the money represented by the value of positions, you will need to sell and realize the capital gain. And, since tax-loss harvesting results in lowering the cost basis of positions, the realized gain and resulting taxes will be larger when realized than if the positions were never harvested.