Recently two investment management companies, Betterment and Wealthfront, have gained an impressive amount of popularity. As you might already be aware, I'm quite skeptical of investment management firms as I've seen the dark side of the financial planning industry. Regardless, I wanted to research both offerings and compare the two in a "Betterment vs. Wealthfront" robo-advisor death match. I wanted to do this review mainly because I'm open to selecting one of these for my own personal use. Before we get into the details lets discuss the fundamental concepts that these services are based on.
What is a Robo-Advisor?
Despite what the investment industry will assure you (mutual and hedge fund managers, commission based financial advisers, stock brokers, etc.), investment allocation decisions can be made solely using various mathematical models. Sure, in the investment allocation decision process you will need to identify risk preferences (subjective assessment), but those are quickly quantified for use in portfolio construction. All other required data (such as investment time horizon, retirement needs, age, current income, etc.) is numerical.
With that said, a robo-advisor is a mathematical model that uses your data and individual circumstances to create a "personalized" portfolio. While a robo-advisor can eliminate the need for professional help to construct a long-term retirement portfolio, it will not satisfy the investment needs of everyone. If you require savvy arbitrage or hedging strategies in your portfolio then a robo-advisor is not for you. Additionally, you will not be able to choose what assets (stocks, funds, bonds, etc.) you invest in, the machine will do that for you. Betterment and Wealthfront are both robo-advisors and utilize mathematical models to automate asset allocation.
Passive Management and Modern Portfolio Theory
Both Betterment and Wealthfront are built on Modern Portfolio Theory (MPT) concepts. Harry Markowitz founded this theory with the understanding that portfolios can be constructed to maximize expected return based on a defined level of risk. Modern Portfolio Theory also suggests that efficient portfolios (optimized based on risk and return) can be constructed by varying allocations to asset classes (i.e. stocks and bonds). This leads to an emphasis on choosing the right blend of stocks, bonds and cash verses choosing one stock over the other.
In addition to utilizing Modern Portfolio Theory to drive asset allocation decisions, Betterment and Wealthfront both take a passive approach to portfolio management. Eventhough they take a passive approach to investing, they will step in and rebalanced the portfolio as needed. Taking this approach keeps transaction costs and fees low. It's wise to take advantage of dollar cost averaging when using these service by setting up automatic investments.
Betterment vs. Wealthfront: The Duel
Now that we have a fundamental understanding of Modern Portfolio Theory and robo-advisors, it's time for Betterment vs. Wealthfront!
When comparing these two services it is clear that they are both extremely similar. The only differences that will matter to the majority of main street investors is cost and initial deposit requirements. The advantages of choosing one over the other truly depends on your individual circumstances.
If you are looking to start building a retirement portfolio from scratch, Betterment will allow you to open an account with no initial deposit. This is as long as you agree to automatically deposit $100 per month into your account. This is a huge advantage for those just starting out. However, the downside to starting out with Betterment is that their fees are higher for accounts under $10,000.
I would personally take advantage of Betterment's low deposit requirement if I didn't have the $5,000 Wealthfront requires as an initial deposit. Additionally, I suspect if you have the $5,000 to use as an initial deposit when using Wealthfront, you won't stay in their "free" account status for long.
I'm attracted to these services for the automatic allocation of investment funds. I'm a advocate of paycheck allotments used to contribute to investment accounts, however in practice it can become burdensome to manage. Thus paying a service like Betterment or Wealthfront to execute the transactions for me is a nice option to have.