Is Wealthfront Worth it?
I like money. That’s pretty normal. What’s weird is that I like thinking about money, to the point where a ‘quiet night in’ usually means making pickles and doing my finances. Last year I got my taxes in the day after I got my W2. I’m just into money.
A while back a friend recommended Wealthfront, a robotic investing service. They manage your investment money for you, claiming to get much higher returns than the average investor or even most professionals. They also do automatic rebalancing, tax lost harvesting, and all sorts of other fun things, all for just 0.25% of your portfolio annually. At the time I was just getting into investing, so I figured hey, might as well try it out. I eventually put 9,999 dollars in it (the max before fees kick in) and then continued investing in Vanguard, managing that part of my portfolio myself.
About a month ago I contacted Vanguard to get a few questions answered. Here’s how it went.
Me: “Can you tell me a little more about my risk profile?”
Vanguard: “Sure, here’s 30 pages of analysis, projections, and references.”
Emboldened by this, I contacted Wealthfront too.
Me: “Can you tell me a little more about my risk profile?”
Wealthfront: “Your risk is ten.”
Me: “Yeah, but what does that mean? Do you have historical performance for a risk ten portfolio?”
Wealthfront: “We have a graph.”
Me: “Can you tell me what were the average returns per quarter?”
Wealthfront: “It’s different for everyone.”
Me: “Can you tell me what were my returns per quarter?”
Me: “Can you at least give me the raw data?”
Wealthfront: “Have you considered setting up an autodeposit? 500 dollars a month could increase your account by 76,000 in ten years!”
Me: “Isn’t that just a 4% compounded return?”
I like money. I also like being very petty. So I decided to manually answer all my questions using the absolutely amazing Portfolio Visualizer and see what it says about Wealthfront. Here we go.
Disclaimer: I’m not a financial person. I’m a programmer who’s Dunning-Krugerred his way into thinking he’s an expert in everything. Please don’t take this as financial advice. Take it as some guy just complaining on the internet a lot.
Does Wealthfront make you money?
One of the counterintuitive things in investing is what “high risk” means. For funds, ‘high risk’ doesn’t mean ‘likely will lose a lot, but might gain a lot’. It means ‘high median return, high standard deviation.’ This means low-risk funds are for short-term investments, while high-risk funds are for long-term investments, where the fluctuations will even out. I’m 24, debt-free, with no major expenses on the horizon. I can afford to be very risky. With that in mind, let’s look at what happens when we invest $10,000 in Wealthfront’s max risk distribution:
Not bad. You’re making about 3% per year, and if you adjust to the bottom of the stock market crash (please don’t ever do this) you’re looking at a solid 11% percent increase! These numbers are actually a little high, because we’re not accounting for the .25% Wealthfront fee, but it gives us a rough gauge.
Now let’s compare it to investing in just the S&P 500:
What about diversification?
Okay, that’s not a completely fair comparison. We’re comparing a single, volatile index to a diversified portfolio. Generally, diversification is better than throwing everything into one fund and hoping for the best. That’s because different kinds of investments do better at different times, and by only picking one you miss good years on the rest and be oversensitive to bad years on your own. This pretty awesome chart from BlackRock sums it up nicely:
Sometimes US markets give the most return. Sometimes it’s world markets. Sometimes it’s fixed income. What’s important is that it changes year to year, so you’re better off playing the broad game. Wealthfront advertises their diversification as a major asset in their favor:
WEALTHFRONT OFFERS A PERSONALIZED AND GLOBALLY-DIVERSIFIED INVESTMENT PORTFOLIO OF INDEX FUNDS
So let’s look at their max risk distribution. Here’s the actual funds it contains:
Let’s break this down. About a third of your money is following the total US market and 50% is international. Then you have a bit following energy for some reason and finally a slice of bonds. It doesn’t have as high gains right now as the S&P, but it’ll probably do better in the long run.
So yes, Wealthfront gives you diversification. But what if we did it ourselves? Wealthfront had a 95% stock/5% bond allocation, so let’s follow that. Vanguard recommends about 40% of your stocks be international, which is about 35% of the total portfolio. So let’s do 60% domestic market, 35% international market, and 5% bonds. Here’s what we get.
Our own allocation does better overall, and that’s not even accounting for the Wealthfront fee. More importantly, it’s roughly correlated with the Wealthfront allocation, and moves up and down in the roughly same magnitude. If the Wealthfront balance has diversity, then so do we, and it only took us a few seconds to think it up. Diversification may be a valuable advantage, but by no means is Wealthfront the only way to get it.
What about risk tolerance?
But what if you want less risk? Maybe you have a short term goal. Maybe the market is volatile and we flinch (DON’T DO THIS). With Wealthfront, it’s easy to make a lower-risk, diverse portfolio. Here’s the distribution they give us for a risk of 4:
This has performed better than “max risk” Wealthfront portfolio over the past 8 years, mostly because it lost less in the 2008 crash. Bonds just did better for a while. Regardless, with Wealthfront you just pick a number and it does the rest for you. And it figures out, based on a basic questionnaire, your risk tolerance, which can be pretty reassuring.
Again, though, this isn’t anything new or special or even convenient that Wealthfront provides. Here’s a piece from one of my favorite charts:
Look at the “average annual return” and “years with a loss.” Choose the graph with the most years you’re comfortable with. Make that investment percentage in bonds. Split your remaining money 60/40 US/International stocks. Let’s pick ‘4’ here, too, for 40% bonds, 35% US stock, 25% international:
As for the questionnaire, that’s not particularly new either. Once again, the services Wealthfront offers are already widely available, with lower fees and more transparency.
What about rebalancing?
Wealthfront advertises it regularly ‘rebalances’ your portfolio. It lists this as one of the big advantages of using the service, claiming it leads to a .4% increase over the lifetime of your investment. That’d more than make up for the .25% fee.
A study performed by David Swensen, Chief Investment Officer of Yale University, found that threshold-based rebalanced portfolios earned an average of 0.4% more per year over 10 years than portfolios that were not rebalanced.
Thing is, rebalancing isn’t actually that complicated an idea. Over time, as your assets gain and lose value, your portfolio’s risk changes. Like we have a long string of good years and your 60/40 stock/bond ratio becomes 80/20. Now you’ve got a riskier portfolio, and should move money from stocks into bonds to go back to your old ratio.
This sounds like it’d be difficult, especially if you’ve got a lot of funds you’re trying to rebalance regularly. In this case, Wealthfront would be providing a great service. Fortunately our lazy portfolio has only three funds and experts say you’re just fine rebalancing annually, so Wealthfront is charging you a chunk of your returns to save you a few minutes each year.
What about no-effort?
This is the big one. We can, with just a little bit of effort on our part, do the same thing Wealthfront does minus overhead. The problem is that there’s still some effort and some expertise required. While I think it’s important to understand how your money works, it can be a really scary topic for a lot of people. Several of my friends have said that even if Wealthfront is a less optimal investment, it’s at least some investment, and one that’s easier to get into than a do-it-yourself.
And this is true: Wealthfront is a completely no-effort investment, and a 4% long-term increase is still much better than the 0.12% return you’d get from Citibank. Even if our lazy portfolio is better, it can never give us that.
Fortunately, this kind of service, once again, isn’t unique to Wealthfront. Vanguard, for example, also offers “all-in-one” funds, aka “funds of funds”, which do exactly the same thing Wealthfront does. Two of them are target retirement funds, which automatically adjust their risk tolerance as you get older, and life strategy funds, which let you pick a risk tolerance and stick with it as long as you want. Let’s compare the highest risk all-in-ones to Wealthfront’s max risk:
Once again we do better by skipping the middleman.
What about Tax-Loss Harvesting?
Tax-loss harvesting is the idea that if you sell assets for less than you bought them, you get a tax write-off. Then you buy a similar (but not too similar) asset and hey, deferred taxes. Not free, because you’ll have to pay extra capital gains of them later, but deferred’s not a bad second. Wealthfront does this for you automatically, swapping between similar ETFs.
This seems like a pretty useful benefit, and I haven’t researched it too in depth, so I don’t have a lot to say on it. The only things I’ll point out is that the jury’s still out on how useful it is and it can be dangerous to have two robo-advisors harvesting for you. That’s because if you sell one asset and buy a “similar enough” one, that’s called a wash, and you can’t write that off. Robo advisors are careful enough not to give you washes, but if you have two and they’re not communicating, they can’t ensure this, and you may end up underpaying on your taxes.
What about technology?
Wealthfront says they aim at a tech-savvy crowd of people who want to use innovative, disruptive technology and leave the big, slow investment companies in the dust. That sounds pretty cool. Then again, Vanguard has full-featured apps on all mobile platforms, lets you do your own analyses, and has two-factor auth. Wealthfront doesn’t even have an Android app yet. An Android app! They’ve been promising one since 2014!
So is Wealthfront worth it?
As always, it depends. If you really value tax-lost harvesting or have only a little to invest, it might be right for you. Otherwise, I personally don’t see the point. Where it innovates it doesn’t provide much value, and the value it does provide isn’t that innovative. And, of course, getting info from them is like pulling teeth.
My Wealthfront money is still there, mostly to keep my tax forms reasonable. As soon as the 2015 year ends, though, I’m planning to transferring to the rest of my self-managed portfolio. I just think it’ll provide better value for my time and money. And, of course, I like thinking about my money, and would rather not have a computer think about it for me. That’s just less fun.