How To Start Investing: “Free” Advisor, Robo-Advisor, or All-In-One ETF?

I recently discussed options for using different types of brokerage and advisor combinations. What to consider for your situation and how that may change over time. For most people, how to start investing is one of the first questions they face. There are many options, including the advisors at your bank, robo-advisors, or learning how to DIY invest. Figuring that out and acting is vital because the most important variable to make compounding work for you is time. Other important variables are the amount you invest and the rate of return (net of costs). So, understanding the potential costs of those investing options is important and not always obvious. Today, I will unpack that and try to put some numbers to it in the context of someone in the first five years of their investing journey.

I have built an investment growth simulator to model investing using different rates of return, but more importantly variables that we can influence: the amount we invest each year, type of advisor, and investment products used. Perhaps, even our behavior by using more automated strategies and avoiding stock-picking or sector bets. In this post, I will describe the model inputs and use the calculator to highlight important practical points for early investors.

To understand what you are paying for your investments and financial advice, you must consider all of the costs. That sounds simple, but it is not always given to you unless you specifically inquire.


Easy To Spot Costs. If You Look.

The two big costs are advisor fees and investment product costs. Frequently, we see one or the other – but we pay both. With “free” advisors, the cost is buried in the mutual funds that they use. Look for the management expense ratio (MER) for the funds to see those fees. It will be on the product monograph or key fund facts.

Other “fee-based” advisors may charge a percentage of the assets invested with them. Remember that they also invest that money in something. That may be mutual funds with a discounted MER or sometimes passive ETFs with their usual low MER. They could also build you a portfolio of stocks and bonds directly. However, that runs into trouble with being too concentrated and high trading costs unless it is a truly massive portfolio.

start investing options

Hidden Costs

Some costs are harder to quantify or control. For example, trading costs and taxes are higher with high turnover active investing strategies. For this analysis, I will ignore the trading costs and taxes – an act of mercy to higher-fee active managers and funds.


Separating Advice & Implementation

The most transparent fee model is an “advice-only” or “fee-only” advisor. They get paid a defined amount to review your portfolio and make you a comprehensive financial plan to address your goals. However, it also highlights the difference between planning and investing. They can give you their opinion, but you must choose your investments and implement the plan. Some provide implementation support as well, but you still need to take responsibility for your decisions and pull the levers.

The combination of DIY investing & advice-only planning is the most cost-effective once portfolios are getting over ~$100K or so. Unfortunately, it is still hard to access for most people starting out.


Facilitating Action

Advisors cost money. However, they can also potentially improve real-life investor outcomes if they are providing valuable advice and service. For example, the most costly mistake is not investing. If an advisor gives you the confidence to invest and makes it convenient enough that you do it now rather than missing time in the market – that is valuable. Possibly, 5-10%/yr based on historical market returns depending on your asset allocation. If you aren’t invested, you miss it. That is a major opportunity cost.


Comfort To Take Investment Risk

Advisors may also help you to invest more aggressively (in a good way). A trusted advisor may enable investors to comfortably invest with a higher allocation to investments with a higher risk and expected return. Besides comfort, the convenient automation of investing and someone between you and the panic-sell button could reduce the behavioral gap. This type of support is particularly valuable when you first start investing and have not experienced the price gyrations of normal markets.


Behavioral Barriers & Coaching

The behavioral gap is the difference between the returns from investing robotically in a fund vs what investors achieve in real life. It is caused by us sitting on cash, or buying and selling emotionally at bad times. That gap can be minimal – asset allocation ETFs had a gap of 0.4%/yr in the most recent Morningstar report. One important nuance of how the behavioral gap is calculated is that there will be a small gap even if there is automated investing. This is due to a slight lag between investment in intervals not being exposed to the full time period. So, a gap of 0.4%/yr may be about as good as it gets.

However, the drag caused by bad behavior can also be unquestionably larger. Those making bets on sectors trailed by a wider margin (2-4%/yr increasing with volatility). The most volatile fund groups had investors trailing the funds by up to 7%. That is also the average. Just ask those who boarded Kathy’s ARKK about how bad it can get (a behavioral gap of over 40%/yr). The potential loss from emotional trading is infinite.

As discussed in a previous post, the balance of cost and benefit will vary by the investor based on how much benefit they get and the cost. That may also change as the portfolio grows and the investor’s ability to manage it changes. The impact of not switching your advisor model when it is warranted can be significant. That could be a switch towards or away from a more full-service model.

To model some common scenarios, I built a management fee and investment growth calculator. Larry Bate’s T-Rex Score is also great if you want to see a straightforward model of how much advisor and fund fees can save you. There have also been attempts to quantify how much return increases an advisor may provide, counteracting those costs. However, many of those numbers are dubious. Of those potential value-adds, behavioral coaching seems the most robust. So, I added behavioral costs in. I also wanted to model partial or complete changes in the advisor & fund model over different parts of an investor’s life.


Return Inputs

In comparing strategies, I assumed that funds of comparable risk would have the same return minus their fees. That is what you’d expect of an efficient market. Anecdotally, that is also what I usually see when I look at people’s portfolios – almost to the exact decimal point. Missing from the model are taxes. Actively managed funds tend to have more turnover and trigger more annual taxes. The taxes would drag on returns.

On the other hand, some portfolio managers may add some value by tax optimizing where different investments are held. That usually looks good on paper, but it is not a sure thing, with a possible benefit in the 0-0.3%/yr range. Perhaps a little higher with some corporate investors. Asset location optimization gets complicated real quick and many advisors don’t go there. Ignoring this doesn’t change the big messages. Also, the impact for a starting investor is likely zero because they are using tax-sheltered accounts.


Advisor Inputs

I separated out the fund costs and advisor costs. So, you could adjust them. I also added a drag for behavioral costs. For today’s modeling, I will make the behavioral gap 0.4%/yr. That implies really good automated investing and just a little lag due to cashflows. That seems reasonable for a full-service advisor and a robo-advisor. It was also the average gap with US asset allocation funds.

That said, it is relatively easy to have a worse behavioral gap. Whether using an advisor or an asset allocation ETF, you could sit on cash instead of depositing it to invest either due to trying to time the market or trying to find time. Using ETFs does not guarantee better behavior. In fact, their convenience to buy, sell, or make sector bets could make it easy to be naughty. If that is you, you may want to increase the gap.

I also added a Fee-Only advisor option. It is averaged over 5-year intervals. We’ll use that in future posts modeling with larger portfolios.


Cashflows

Instead of just looking at the difference if you invested an amount and left it, I put the option to change annual deposits or withdrawals in five-year intervals. There will be times in life when you can invest a lot and times when you will actually be drawing from a portfolio. So, this is more realistic and relatable. That said, I am going to use $50K/yr during accumulation years. That is a lot compared to the average Canadian, but also less than what many high-income professionals must invest to make up for their late start. The comparison between strategies is driven by percentages. So, it holds up regardless of whether it is $50K or $5K.

Bloggers love to beat up on “free” bank-model advisors due to the drag of the massive fees embedded in the mutual funds that they sell. Myself included. However, they do make getting invested relatively easy. Also, with very little money invested, the “free advice” is cheaper than fee-only and more accessible than fee-based advisors. Unfortunately, the quality of advice is pretty variable from what I have seen. Still, it is sometimes better than nothing. As long as it is temporary and you can make for the exit when it is appropriate.


Banks are better than nothing.

Investor Bobby starts investing at age 30. They haven’t really learned much about investing at this point. Getting their career off the ground and managing their growing household occupies most of their time and mental energy. Bobby has excess cash to invest but doesn’t know where to start. Their bank computer system notes this, and they get a phone call to meet with a “free advisor” for help. The advisor is very nice and does a good job assessing risk tolerance and financial goals. Note: if they do not spend a decent amount of time doing this, it is a major red flag. Go elsewhere. After that, they get Bobby invested in a globally diversified mutual fund portfolio. The overall MER is 2%/yr.

Below is a simulation of how that would do after 5 more years compared to Bob just leaving the money as cash earning nothing.

After five years, they have $337K instead of just $300K. Much better than doing nothing. They also feel good because they have made money and their advisor is very nice. However, they don’t realize that they could have potentially done better than that.


Better than that? Robo-Advisor.

If Bobby at least knows that they have RRSP room and TFSA room to use, they could have opened those account types using a robo-advisor. They use the robo-advisor to do a risk tolerance and goal assessment online. It then builds a suitable portfolio using low-cost ETFs. Bobby can set up automatic deposits to invest regularly with no effort. Just as turn-key as a “free advisor”, but no free coffee.

There are lots of robo-advisor options. Wealthsimple managed portfolios is a popular one. Questrade’s Questwealth is the cheapest. There is also an affiliate link to Qtrade Guided Portfolios on my site. These options emphasize a simple automated user experience to get you investing regularly. For a relatively low cost. I will use total fees (robo-fee & underlying fund MERs) for a robo-advisor option of roughly 0.65%/yr for our investor.

It is important to realize that robo-advisors are generally actively managed. They typically use passive ETFs, but the managers make decisions and tweak the weightings based on their outlook. That makes the outcome more variable. I gave the benefit of the doubt to active mutual funds that they simply trail by costs. So, I will do the same with robo-advisors for the model. However, the reality is that active managers can really trail if their predictions of the future are wrong. Even with a good rationale for decisions based on current information, the future is unpredictable and often unfolds differently.

Assuming similar risk portfolios to our “Free-Advisor” mutual funds, that 1.35%/yr savings translates into $12K more money after five years. You could use that to buy a robot that serves you coffee.


An Asset Allocation ETF & A Clean House

Making the space to learn to invest while balancing an early career can be challenging. However, if you think of your time and money more broadly, spending the time to learn a simple and effective DIY investing strategy is time well spent. You could easily hire a cleaner, or other helper, or order food to buy that time back with the amount of money saved.

The other advantage early investors have is that their best investing options are somewhat simple. It is usually catching up on unused RRSP and/or TFSA room to start. I have even made a step-by-step guide (with pictures) to make it easier. You can also learn more over time as your portfolio grows and you gain experience. Whether you DIY or use an advisor, that knowledge is important. Gaining some basic knowledge upfront while investing smaller amounts and learning more as you go gets you off to a good start and avoids either learning a bunch at once later or never learning. Or learning more, but finding it hard to extract yourself from a sub-optimal situation.

Assuming the same risk portfolio, the 0.45%/yr saved by using an all-in-one ETF compared to a robo-advisor translates to about $4K more money than the model robo-advisor after 5 years. That is a sliver of a difference in the above chart. It also assumes that you put in the time to build some basic knowledge, skills, and are disciplined enough to buy your ETF regularly when you have money. The $4K could pay handsomely for that time. You could keep that money or use it to buy time. However, it would also only take a small amount of excess behavioral gap to make them even. So, developing the habit of investing regularly and ignoring the expensive storytellers to stay invested is crucial.

There are some key messages from today’s exercise in modeling different options for people to start investing.


Consider All of Your Costs

Accept that you cannot predict or control what markets do, and that advisors cannot either. You can control costs. Be aware that your cost includes both the advisor fee and the product fees. The more you trade or if you use an actively managed fund, turnover will also mean trading costs within the fund. Plus, you may owe taxes on some of the gains now instead of later. On the other side of the equation, advisors or products that make it easier for you to invest more comfortably and consistently save you from missing time in the market, not taking enough compensated risk, or making costly emotional trades. That saves you money too.


When Something is Better Than Nothing

The bulk of the growth in your accounts when starting out is from contributions. Not investment returns. Focus on getting started and making regular contributions.

As long as it is a diversified strategy that suits your risk tolerance, the impact of doing that rather than sitting in excess cash is huge. The easiest way to do that is using a fund. Most commonly, that is done using mutual funds coupled with a “free advisor”. Banks see excess cash in accounts often triggering a call. People also trust their banks. While those fees are higher than optimal, if it gets you invested that 2%/yr is better than missing market returns that are much higher on average. They tend to “strike first” and do not mention your other options like a robo-advisor or DIY investing. Some may even try to scare you away from those options. Makes sense. They are usually trained through their employers to promote active management, and the inconvenient truths of real-world performance relative to lower-cost strategies are omitted.

Another potential advantage is that this is one of the few ways that those with little money to invest can access a human advisor. While they may be focused on selling their mutual funds to you, ask them about some of your other financial planning questions. At best, it may help. At worst, if they give poor or no advice. In that case, consider going elsewhere. Unfortunately, the quality of advice is highly variable and dependent on the individual advisor in the bank model setting.


A Robo-Advisor Is Convenient & Easy

While it is common to get started using a bank retail mutual fund, that is probably not optimal. I wrote about it because it is better than nothing. Also, I don’t want people who started that way to waste time and energy beating themselves up over it. Now that you know better, focus on moving forward in a better way.

The largest benefit is automatic deposits and investing for you. A robo-advisor is much more cost-effective for doing that. That could translate into significant savings even within a few years compared to higher-fee mutual funds.

The difference in savings between a Robo-advisor and using an asset allocation ETF is pretty small. So, if this gets you invested while you work on the knowledgebase and make the time to use an all-in-one asset allocation ETF – that is not a big deal. It is better to take the time and do it right. You can also scale that up as your portfolio and experience grows. While DIY ETF index investing may ultimately be your best option, a robo-advisor is a reasonable bridge to getting there.


Starting Investing is Only The Beginning

While getting invested in a diversified way is the most important early variable, it is only the beginning. I still favor using a passive ETF investing approach. There are several reasons for that.

First, you will need to develop some basic knowledge about investing. Otherwise, you will be vulnerable to bad advice. You most likely won’t even recognize it. Whatever platform you use, you can still get in your own way. Understanding how markets work and developing good habits helps that.

The second reason is that while the differences in fees seem minor in the five-year window that I modeled today, the impact compounds over time. The sooner you educate yourself and move to the best model for your situation, the better. Unfortunately, compounding fees are sneaky. They often only grab people’s attention after a decade or more. When the underperformance is obvious.

While I favor ETF index investing and managing my own portfolio, the right answer will be different for everyone. It may also change over your investing career. Early on, simply investing using a diversified and suitable portfolio is the most important factor. Choose an option and start investing However, it should only be the beginning. Learn more, reflect, and re-evaluate as you go.

Leave a Reply

Your email address will not be published. Required fields are marked *