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Guide to Choosing the Right IRA: Traditional or Roth?

Editorial Note: The content of this article is based on the author’s opinions and recommendations alone and is not intended to be a source of investment advice. It has not been previewed, commissioned or otherwise endorsed by any of our network partners.

Guide to Choosing the Right IRA: Traditional or Roth?

The Roth IRA versus traditional IRA debate has raged on for years.

What many retirement savers may not know is that most of the debate about whether it’s better to contribute to a traditional IRA or a Roth IRA is flawed.

You’ve probably heard that young investors are better off contributing to a Roth IRA because they’ll likely be in a higher tax bracket when they’re older. You’ve probably also heard that if you’re in the same tax bracket now and in retirement, a traditional IRA and Roth IRA will produce the same result.

These arguments are part of the conventional wisdom upon which many people make their decisions, and yet each misses some important nuance and, in some cases, is downright incorrect.

The Biggest Difference Between Traditional and Roth IRAs

There are several differences between traditional and Roth IRAs, and we’ll get into many of them below.

The key difference is in the tax breaks they offer.

Contributions to a traditional IRA are not taxed up front. They are tax-deductible, meaning they decrease your taxable income for the year in which you make the contribution. The money grows tax-free inside the account. However, your withdrawals in retirement are treated as taxable income.

Contributions to a Roth IRA are taxed up front at your current income tax rate. The money grows tax-free while inside the account. And when you make withdrawals in retirement, those withdrawals are not taxed.

Whether it’s better to get the tax break when you make the contribution or when you withdraw it in retirement is the centerpiece of the traditional vs. Roth IRA debate, and it’s also where a lot of people use some faulty logic.

We’ll debunk the conventional wisdom in just a bit, but first we need to take a very quick detour to understand a couple of key tax concepts.

The Important Difference Between Marginal and Effective Tax Rates

Don’t worry. We’re not going too far into the tax weeds here. But there’s a key point that’s important to understand if you’re going to make a true comparison between traditional and Roth IRAs, and that’s the difference between your marginal tax rate and your effective tax rate.

When people talk about tax rates, they’re typically referring to your marginal tax rate. This is the tax rate you pay on your last dollar of income, and it’s the same as your current tax bracket. For example, if you’re in the 15% tax bracket, you have a 15% marginal tax rate, and you’ll owe 15 cents in taxes on the next dollar you earn.

Your effective tax rate, however, divides your total tax bill by your total income to calculate your average tax rate across every dollar you earned.

And these tax rates are different because of our progressive federal income tax, which taxes different dollars at different rates. For example, someone in the 15% tax bracket actually pays 0% on some of their income, 10% on some of their income, and 15% on the rest of their income. Which means that their total tax bill is actually less than 15% of their total income.

For a simple example, a 32-year-old couple making $65,000 per year with one child will likely fall in the 15% tax bracket. That’s their marginal tax rate.

But after factoring in our progressive tax code and various tax breaks like the standard deduction and personal exemptions, they will only actually pay a total of $4,114 in taxes, making their effective tax rate just 6.33% (calculated using TurboTax’s TaxCaster).

As you can see, the couple’s effective tax rate is much lower than their marginal tax rate. And that’s almost always the case, no matter what your situation.

Keep that in mind as we move forward.

Why the Conventional Traditional vs. Roth IRA Wisdom Is Wrong

Most of the discussion around traditional and Roth IRAs focuses on your marginal tax rate. The logic says that if your marginal tax rate is higher now than it will be in retirement, the traditional IRA is the way to go. If it will be higher in retirement, the Roth IRA is the way to go. If your marginal tax rate will be the same in retirement as it is now, you’ll get the same result whether you contribute to a traditional IRA or a Roth IRA.

By this conventional wisdom, the Roth IRA typically comes out ahead for younger investors who plan on increasing their income over time and therefore moving into a higher tax bracket or at least staying in the same tax bracket.

But that conventional wisdom is flawed.

When you’re torn between contributing to a traditional or Roth IRA, it’s almost always better to compare your marginal tax rate today to your effective rate in retirement, for two reasons:

  1. Your traditional IRA contributions will likely provide a tax break at or near your marginal tax rate. This is because federal tax brackets typically span tens of thousands of dollars, while your IRA contributions max out at $5,500 for an individual or $11,000 for a couple. So it’s unlikely that your traditional IRA contribution will move you into a lower tax bracket, and even if it does, it will likely be only a small part of your contribution.
  2. Your traditional IRA withdrawals, on the other hand, are very likely to span multiple tax brackets given that you will likely be withdrawing tens of thousands of dollars per year. Given that reality, your effective tax rate is a more accurate representation of the tax cost of those withdrawals in retirement.

And when you look at it this way, comparing your marginal tax rate today to your effective tax rate in the future, the traditional IRA starts to look a lot more attractive.

Let’s run the numbers with a case study.

A Case Study: Should Mark and Jane Contribute to a Traditional IRA or a Roth IRA?

Mark and Jane are 32, married, and have a 2-year-old child. They currently make $65,000 per year combined, putting them squarely in the 15% tax bracket.

They’re ready to save for retirement, and they’re trying to decide between a traditional IRA and a Roth IRA. They’ve figured out that they can afford to make either of the following annual contributions:

  • $11,000 to a traditional IRA, which is the annual maximum.
  • $9,350 to a Roth IRA, which is that same $11,000 contribution after the 15% tax cost is taken out. (Since Roth IRA contributions are nondeductible, factoring taxes into the contribution is the right way to properly compare equivalent after-tax contributions to each account.)

So the big question is this: Which account, the traditional IRA or Roth IRA, will give them more income in retirement?

Using conventional wisdom, they would probably contribute to the Roth IRA. After all, they’re young and in a relatively low tax bracket.

But Mark and Jane are curious people, so they decided to run the numbers themselves. Here are the assumptions they made in order to do that:

  • They will continue working until age 67 (full Social Security retirement age).
  • They will continue making $65,000 per year, adjusted for inflation.
  • They will receive $26,964 per year in Social Security income starting at age 67 (estimated here).
  • They will receive an inflation-adjusted investment return of 5% per year (7% return minus 2% inflation).
  • At retirement, they will withdraw 4% of their final IRA balance per year to supplement their Social Security income (based on the 4% safe withdrawal rate).
  • They will file taxes jointly every year, both now and in retirement.

You can see all the details laid out in a spreadsheet here, but here’s the bottom line:

  • The Roth IRA will provide Mark and Jane with $35,469 in annual tax-free income on top of their Social Security income.
  • The traditional IRA will provide $37,544 in annual after-tax income on top of their Social Security income. That’s after paying $4,184 in taxes on their $41,728 withdrawal, calculating using TurboTax’s TaxCaster.

In other words, the traditional IRA will provide an extra $2,075 in annual income for Mark and Jane in retirement.

That’s a nice vacation, a whole bunch of date nights, gifts for the grandkids, or simply extra money that might be needed to cover necessary expenses.

It’s worth noting that using the assumptions above, Mark and Jane are in the 15% tax bracket both now and in retirement. According to the conventional wisdom, a traditional IRA and Roth IRA should provide the same result.

But they don’t, and the reason has everything to do with the difference between marginal tax rates and effective tax rates.

Right now, their contributions to the traditional IRA get them a 15% tax break, meaning they can contribute 15% more to a traditional IRA than they can to a Roth IRA without affecting their budget in any way.

But in retirement, the effective tax rate on their traditional IRA withdrawals is only 10%. Due again to a combination of our progressive tax code and tax breaks like the standard deduction and personal exemptions, some of it isn’t taxed, some of it is taxed at 10%, and only a portion of it is taxed at 15%.

That 5% difference between now and later is why they end up with more money from a traditional IRA than a Roth IRA.

And it’s that same unconventional wisdom that can give you more retirement income as well if you plan smartly.

5 Good Reasons to Use a Roth IRA

The main takeaway from everything above is that the conventional traditional versus Roth IRA wisdom is wrong. Comparing marginal tax rates typically underestimates the value of a traditional IRA.

Of course, the Roth IRA is still a great account, and there are plenty of situations in which it makes sense to use it. I have a Roth IRA myself, and I’m very happy with it.

So here are five good reasons to use a Roth IRA.

1. You Might Contribute More to a Roth IRA

Our case study above assumes that you would make equivalent after-tax contributions to each account. That is, if you’re in the 15% tax bracket, you would contribute 15% less to a Roth IRA than to a traditional IRA because of the tax cost.

That’s technically the right way to make the comparison, but it’s not the way most people think.

There’s a good chance that you have a certain amount of money you want to contribute and that you would make that same contribution to either a traditional IRA or a Roth IRA. Maybe you want to max out your contribution and the only question is which account to use.

If that’s the case, a Roth IRA will come out ahead every time simply because that money will never be taxed again.

2. Backdoor Roth IRA

If you make too much to either contribute to a Roth IRA or deduct contributions to a traditional IRA, you still might be eligible to do what’s called a backdoor Roth IRA.

If so, it’s a great way to give yourself some extra tax-free income in retirement, and you can only do it with a Roth IRA.

3. You Might Have Other Income

Social Security income was already factored into the example above. But any additional income, such as pension income, would increase the cost of those traditional IRA withdrawals in retirement by increasing both the marginal and effective tax rate.

Depending on your other income sources, the tax-free nature of a Roth IRA may be helpful.

4. Tax Diversification

You can make the most reasonable assumptions in the world, but the reality is that there’s no way to know what your situation will look like 30-plus years down the road.

We encourage people to diversify their investments because it reduces the risk that any one bad company could bring down your entire portfolio. Similarly, diversifying your retirement accounts can reduce the risk that a change in circumstances would result in you drastically overpaying in taxes.

Having some money in a Roth IRA and some money in a traditional IRA or 401(k) could give you room to adapt to changing tax circumstances in retirement by giving you some taxable money and some tax-free money.

5. Financial Flexibility

Roth IRAs are extremely flexible accounts that can be used for a variety of financial goals throughout your lifetime.

One reason for this is that your contributions are available at any time and for any reason, without tax or penalty. Ideally you would be able to keep the money in your account to grow for retirement, but it could be used to buy a house, start a business, or simply in case of emergency.

Roth IRAs also have some special characteristics that can make them effective college savings accounts, and as of now Roth IRAs are not subject to required minimum distributions in retirement, though that could certainly change.

All in all, Roth IRAs are more flexible than traditional IRAs in terms of using the money for nonretirement purposes.

3 Good Reasons to Use a Traditional IRA

People love the Roth IRA because it gives you tax-free money in retirement, but, as we saw in the case study above, that doesn’t always result in more retirement income. Even factoring in taxes, and even in situations where you might not expect it, the traditional IRA often comes out ahead.

And the truth is that there are even MORE tax advantages to the traditional IRA than what we discussed earlier. Here are three of the biggest.

1. You Can Convert to a Roth IRA at Any Time

One of the downsides of contributing to a Roth IRA is that you lock in the tax cost at the point of contribution. There’s no getting that money back.

On the other hand, contributing to a traditional IRA gives you the tax break now while also preserving your ability to convert some or all of that money to a Roth IRA at your convenience, giving you more control over when and how you take the tax hit.

For example, let’s say that you contribute to a traditional IRA this year, and then a few years down the line either you or your spouse decides to stay home with the kids, or start a business, or change careers. Any of those decisions could lead to a significant reduction in income, which might be a perfect opportunity to convert some or all of your traditional IRA money to a Roth IRA.

The amount you convert will count as taxable income, but because you’re temporarily in a lower tax bracket you’ll receive a smaller tax bill.

You can get pretty fancy with this if you want. Brandon from the Mad Fientist, has explained how to build a Roth IRA Conversion Ladder to fund early retirement. Financial planner Michael Kitces has demonstrated how to use partial conversions and recharacterizations to optimize your tax cost.

Of course, there are downsides to this strategy as well. Primarily there’s the fact that taxes are complicated, and you could unknowingly cost yourself a lot of money if you’re not careful. And unlike direct contributions to a Roth IRA, you have to wait five years before you’re able to withdraw the money you’ve converted without penalty. It’s typically best to speak to a tax professional or financial planner before converting to a Roth IRA.

But the overall point is that contributing to a traditional IRA now gives you greater ability to control your tax spending both now and in the future. You may be able to save yourself a lot of money by converting to a Roth IRA sometime in the future rather than contributing to it directly today.

2. You Could Avoid or Reduce State Income Tax

Traditional IRA contributions are deductible for state income tax purposes as well as federal income tax purposes. That wasn’t factored into the case study above, but there are situations in which this can significantly increase the benefit of a traditional IRA.

First, if you live in a state with a progressive income tax code, you may get a boost from the difference in marginal and effective tax rates just like with federal income taxes. While your contributions today may be deductible at the margin, your future withdrawals may at least partially be taxed at lower rates.

Second, it’s possible that you could eventually move to a state with either lower state income tax rates or no income tax at all. If so, you could save money on the difference between your current and future tax rates, and possibly avoid state income taxes altogether. Of course, if you move to a state with higher income taxes, you may end up losing money on the difference.

3. It Helps You Gain Eligibility for Tax Breaks

Contributing to a traditional IRA lowers what’s called your adjusted gross income (AGI), which is why you end up paying less income tax.

But there are a number of other tax breaks that rely on your AGI to determine eligibility, and by contributing to a traditional IRA you lower your AGI you make it more likely to qualify for those tax breaks.

Here’s a sample of common tax breaks that rely on AGI:

  • Saver’s credit – Provides a tax credit for people who make contributions to a qualified retirement plan and make under a certain level of AGI. For 2017, the maximum credit is $2,000 for individuals and $4,000 for couples.
  • Child and dependent care credit – Provides a credit of up to $2,100 for expenses related to the care of children and other dependents, though the amount decreases as your AGI increases. Parents with young children in child care are the most common recipients of this credit.
  • Medical expense deduction – Medical expenses that exceed 10% of your AGI are deductible. The lower your AGI, the more likely you are to qualify for this deduction.
  • 0% dividend and capital gains tax rate – If you’re in the 15% income tax bracket or below, any dividends and long-term capital gains you earn during the year are not taxed. Lowering your AGI could move you into this lower tax bracket.

Making a Smarter Decision

There’s a lot more to the traditional vs. Roth IRA debate than the conventional wisdom would have you believe. And the truth is that the more you dive in, the more you realize just how powerful the traditional IRA is.

That’s not to say that you should never use a Roth IRA. It’s a fantastic account, and it certainly has its place. It’s just that the tax breaks a traditional IRA offers are often understated.

It’s also important to recognize that every situation is different and that it’s impossible to know ahead of time which account will come out ahead. There are too many variables and too many unknowns to say for sure.

But with the information above, you should be able to make a smarter choice that makes it a little bit easier to reach retirement sooner and with more money.

Advertiser Disclosure: The products that appear on this site may be from companies from which MagnifyMoney receives compensation. This compensation may impact how and where products appear on this site (including, for example, the order in which they appear). MagnifyMoney does not include all financial institutions or all products offered available in the marketplace.

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Review of Vanguard Personal Advisor Services

Editorial Note: The content of this article is based on the author’s opinions and recommendations alone and is not intended to be a source of investment advice. It has not been previewed, commissioned or otherwise endorsed by any of our network partners.

Vanguard Personal Advisor Services is the investment advisory service offered through Vanguard Advisers, a wholly owned subsidiary of Vanguard, Inc., one of the world’s largest investment management firms. Vanguard Personal Advisor Services focuses on serving individual investors, including high net worth individuals. Clients work with human advisors, but also have access to Vanguard’s digital advice platform.

All information included in this profile is accurate as of April 2, 2020. For more information, please consult Vanguard Personal Advisor Services website.

Assets under management: $83.7 billion
Minimum investment: $50,000
Fee structure: A percentage of AUM; one-time financial planning fee for some workplace retirement plan participants
Headquarters: 100 Vanguard Boulevard
Malvern, PA 19355
vanguard.com
800-416-8420

Overview of Vanguard Personal Advisor Services

Vanguard Personal Advisor Services is the investment advisory arm of Vanguard Advisers, a wholly owned subsidiary of Vanguard. The advisory part of the business launched in 2015, decades after Vanguard was founded in 1975 by the late John “Jack” Bogle.

Bogle introduced the first-ever index fund to retail investors and encouraged them to buy and hold a diverse basket of low-cost investments. Though Bogle passed away last year, the firm aims to continue his legacy.

Vanguard Personal Advisor Services is focused on providing ongoing advisory account services for individual investors as well as point-in-time financial planning for retirement plan participants. Vanguard Personal Advisor Services oversees $83.7 billion of Vanguard Advisers’ total $221 billion in assets under management (AUM).

Which types of clients does Vanguard Personal Advisor Services serve?

Vanguard Personal Advisor Services primarily serves individuals, including high net worth investors and those who get services through their workplace retirement plans. For reference, the SEC defines high net worth individuals as those with at least $750,000 under management or a net worth above $1.5 million.

The individual investors either come for financial planning via their workplace 401(k) plans, or they are retail investors with an IRA or other account with Vanguard. In the latter case, there’s a minimum investment requirement of $50,000. The firm does not provide financial planning services to clients who do not have accounts with Vanguard.

Services offered by Vanguard Personal Advisor Services

Vanguard Personal Advisor Services offers financial planning and point-in-time advice to participants in Vanguard workplace retirement plans. Those participants are not eligible for managed account services for assets in those plans.

Clients who have an IRA or other retail account worth at least $50,000 with Vanguard can use Vanguard Personal Advisor Services to get a customized financial plan and enroll in the firm’s “ongoing advised services.” That gives an advisor the authority to make trades on the client’s behalf in accordance with their agreed-upon plan. It also allows participants to call advisors about advice on financial issues that arise as they hit life’s milestones, such as buying a new house or having grandchildren.

Here is a full list of services offered by Vanguard Personal Advisor Services:

  • Investment advisory services/portfolio management
    • Asset allocation strategies
  • Financial planning
    • Retirement planning
    • Estate planning
    • Charitable giving
    • Succession planning
    • Tax planning and management

How Vanguard Personal Advisor Services invests your money

All participants in Vanguard Personal Advisor Services get a financial plan, including the creation of a portfolio with a diverse asset allocation that reflects your personal financial situation, goals and risk tolerance. To do that, the advisors rely on an algorithm, which recommends an investing track and glide path, or asset allocation strategy, that meets your needs. The investment tracks range from very conservative to very aggressive, and the glide paths adjust over time, depending on your goals.

Each portfolio includes a variety of Vanguard index funds with holdings in a specific asset class, such as international stocks or short-term bonds, but it does not recommend investments in individual stocks or bonds. In addition to diversification, the portfolios take taxes into account, aiming to keep the investments as tax-efficient as possible. In general, Vanguard encourages a long-term, buy-and-hold approach rather than switching strategies based on market performance.

Fees Vanguard Personal Advisor Services charges for its services

Employees who use Vanguard Financial Planning Services through their workplace retirement plan pay $1,000 for the service if they have less than $50,000 in assets with Vanguard, and $250 if they have $50,000 to $500,000 with Vanguard. The firm may waive that fee for clients who are over the age of 55 or who have more than $500,000 invested with Vanguard.

For clients of Vanguard Personal Advisor who don’t have a workplace retirement plan and are enrolled in the ongoing advised services, the firm charges a percentage of assets under management. Rates run from 0.30% for accounts of less than $5 million to 0.05% for accounts over $25 million.

Assets under management Annual rate
Under $5 million 0.30%
$5 million to under $10 million 0.20%
$10 million to under $25 million 0.10%
$25 million and over 0.05%

In addition to the above fees, you may also pay fund fees, annuity fees, account fees or retirement plan fees.

Vanguard Personal Advisor Services’s highlights

  • A dedication to low fees. Vanguard literally invented index investing, and the firm remains dedicated to keeping its fees low. Its fee schedule is substantially lower than the industry average total fee rate of 1.17%, according to RIA in a Box.
  • Excellent reputation. Vanguard Personal Advisor Services was named the “Brand of the Year” in 2019 for digital investing by Harris Poll EquiTrends. The title was awarded based on consumer devotion and respect.
  • Fee-only model. Advisors don’t receive commissions for selling products or making recommendations, so they do not have a financial incentive to do so, which can pose a potential conflict of interest.

Vanguard Personal Advisor Services’s downsides

  • High minimum balance for young investors. You need to have $50,000 invested with Vanguard (outside of your workplace retirement plan) to access its investment management services if your employer is not enrolled in the program. That could be a high bar for young investors or for those who haven’t been saving for long.
  • Less potential upside: Since Vanguard’s investment philosophy is built on a buy-and-hold strategy comprised of low-cost funds, you can expect your investments to perform in line with the markets, but advisors aren’t actively trading to try to “beat the market.”
  • Large digital component: While you’ll work with a human advisor to create your initial plan, future check-ins may take place via the platform’s digital interface. Clients with $500,000 or less in assets do not have an assigned financial advisor, though they can call to schedule an appointment at any time.

Vanguard Personal Advisor Services disciplinary disclosures

Vanguard Personal Advisor Services does not have any disciplinary disclosures. All registered investment advisors are required to disclose any legal, regulatory or criminal events in their Form ADV, documents they file with the SEC.

Vanguard Personal Advisor Services onboarding process

To learn more about working with Vanguard, you can call (800) 414-8740 or create an account online to set up an appointment to talk with an advisor. In your initial conversation, you’ll discuss your financial situation and goals, and share information about all your financial accounts. Your advisor(s) will spend a few weeks creating a plan, and then you can decide whether you want to implement that plan and allow them to manage the account on your behalf.

If your portfolio is worth less than $50,000, you’ll work with a team of advisors, while those with a portfolio worth more than $500,000 have a specific, dedicated financial advisor. Advisors will check on your portfolio on a quarterly basis, making adjustments as needed to your asset allocation. You can check in online or call your advisor or team at any time.

Is Vanguard Personal Advisor Services right for you?

The firm may be a good choice if you’re an investor with at least $50,000 looking for a low-cost, low-maintenance way to manage your money (or your employer has chosen Vanguard as its retirement plan provider). Vanguard Personal Advisors offers extremely low fees and boasts a clean disciplinary record.

For investors who have less than $50,000, or who are looking for a more active approach to asset management, another firm might be a better fit. As is always the case when choosing a financial product or service, it’s important to shop around, ask questions of financial advisors and make the choice that’s best for your unique situation.

Advertiser Disclosure: The products that appear on this site may be from companies from which MagnifyMoney receives compensation. This compensation may impact how and where products appear on this site (including, for example, the order in which they appear). MagnifyMoney does not include all financial institutions or all products offered available in the marketplace.

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The 7 Best Robo-advisors of 2020

Editorial Note: The content of this article is based on the author’s opinions and recommendations alone and is not intended to be a source of investment advice. It has not been previewed, commissioned or otherwise endorsed by any of our network partners.

If you’re new to the world of investing in stocks and bonds, knowing where to begin can be an intimidating prospect. Robo-advisors could be the best choice to start your investing journey. They make putting money in the market simple and intuitive utilizing smartphone apps and sophisticated computer algorithms.

Robo-advisors invest your money in diversified portfolios of stocks and bonds that are customized to your needs. Since computers do the work, they are able to charge much lower fees than traditional wealth advisors.

They begin the process with a questionnaire to assess your financial goals and your risk tolerance. Based on your answers, robo-advisors purchase low-cost exchange-traded funds (ETFs) for you and adjust the portfolio — or rebalance, as they say on Wall Street — on a regular basis, with no further intervention required from you.

To match your risk tolerance, robo-advisors offer more aggressive portfolios containing a greater percentage of stock ETFs, or more conservative ones containing a greater percentage of bond ETFs. The robo-advisor will also consider your age in developing your portfolio.

How we chose the best robo-advisors

We regularly review the latest robo-advisor offerings — we’ve evaluated 19 different ones in this round — and have selected our top choices. All of the robo-advisors on this list may well be worth considering, with those at the top scoring the best in our methodology.

To determine our list of the best robo-advisors, we focused on management fees and account minimums, and also considered ease of use and customer support.

The top 7 robo-advisors of 2020

Robo-advisorAnnual Management FeeAverage Expense Ratio (moderate risk portfolio)Account Minimum to Start
Wealthfront0.25%0.09%$500
Charles Schwab Intelligent Portfolios0.00%0.14%$5,000
Betterment0.25% (up to $100,000), 0.40% (over $100,000)0.11%$0
SoFi Automated Investing0.00%0.08%$1
SigFig0.00% (up to $10,000), 0.25% (over $10,000)0.15%$2,000
WiseBanyan0.00%0.12%$1
Acorns$12/yr0.03%-0.15%$5

 

Management Fees

0%

Account Minimum

$100 one-time deposit or $20 monthly deposit

Promotion
N/A
Management Fees

0.25%

Account Minimum

$0

Promotion

Three months free for new customers who are referred by an existing Betterment account holder

Management Fees

0.30%

Account Minimum

$100

Promotion

N/A

Wealthfront — Low fees, high APR for cash account

Wealthfront
Wealthfront’s stand-out features are its low annual cost and free financial planning tools. The 0.25% management fee and 0.09% average ETF expense ratio adds up to one of the lowest annual costs on this list. In addition, Wealthfront includes a cash management account with an attractive 0.26% APY.

Wealthfront continues to steal share in wealth management as customers fed up with high fees leave traditional brokerages and wealth advisors. Human interaction is intentionally minimal at Wealthfront: This could be a benefit to those who want to be left alone, or a drawback for those who would prefer personal attention or who have complicated tax situations.

Wealthfront’s key attributes:

  • Fees: Management fee of 0.25%, plus 0.09% avg ETF expense ratio
  • Minimum starting deposit: $500
  • Investing strategy: Wealthfront invests your money in one of 20 different automated portfolios. Each portfolio is a different mix of 11 low-cost ETFs, which are rated with risk scores from 0.5 (least risk) to 10.0 (most risk).
  • Average annual return over the past five years: 5.40% per year, based on Wealthfront’s mid-level 5.0 risk score.
  • Other notable features: Tax-loss harvesting (see below for a full explanation of tax-loss harvesting) comes standard, also includes an FDIC-insured cash management account yielding 0.26% APY.

LEARN MORE

Charles Schwab Intelligent Portfolios — Brand-name brokerage

Charles Schwab
Intelligent Portfolios can be a smart choice, but do not be misled by the 0% management fees — investing with this robo-advisor still comes at a cost. Intelligent Portfolios requires users to hold 6% to 30% of deposited funds in cash at a 0.70% APY, which will eat into overall returns in years where the market returns above 0.7%. This is on top of an average 0.14% expense ratio for a moderate portfolio. The $5,000 minimum deposit to open an account may also be too high a bar for investors just starting out.

That said, Intelligent Portfolios has an exceptionally detailed description of their ETF selection methodology, and a major brokerage like Schwab can be a good launchpad for folks who anticipate getting deeper into investing. Intelligent Portfolios users get access to Charles Schwab’s 300 U.S. branch locations where you can talk to advisors and handle administrative tasks in person.

Key attributes of Intelligent Portfolios:

  • Fees: Zero management fee, but customers must hold 6% to 30% of their portfolio in cash at 0.7% APR, plus 0.14% avg ETF expense ratio.
  • Minimum starting deposit: $5,000
  • Investing strategy: Schwab invests your money in a custom portfolio with two main components: ETFs representing up to 20 different asset classes, including stocks and bonds; and cash, in the form of a FDIC-insured cash sweep program earning 0.7% APY. Cash must be between 6% and 30% of the portfolio.
  • Average annual return from 3/31/2015 to 12/31/2018: 3.1% per year for medium-risk portfolio
  • Other notable features: Tax loss harvesting available for accounts over $50K, includes access to in-person assistance at over 300 U.S. branch locations.

Learn More

Betterment — Low fees for balances under $100K

Betterment
Betterment offers a full suite of robo-advisor features at low cost with no minimum deposit. The annual management fee for accounts under $100,000 is 0.25%, plus an average 0.11% expense ratio. Unfortunately, accounts over $100,000 will see the annual management fee jump to 0.40%. One advantage Betterment gives to accounts above the $100,000 threshold is that they can actively manage some assets. If active management is your goal, though, you can avoid Betterment’s 0.40% fee by opening a free brokerage account — so if you are managing more than $100,000, you may want to consider a different robo-advisor.

Betterment’s key attributes:

  • Fees: If total balance is less than $100,000, the annual management fee is 0.25% of assets; for balances over $100,000, management fee rises to 0.40% of assets. The average ETF expense ratio is 0.11% (for a 70% stock and 30% bond portfolio).
  • Minimum starting deposit: $0
  • Investing strategy: Betterment invests your money in an automated portfolio comprised of stock and bond ETFs in 12 different asset classes.
  • Average annual return over five years: 6.2% per year on a 50% equity portfolio (July 2013 to July 2018).
  • Other notable features: Tax-loss harvesting comes standard; active management features for clients with $100,000+ balance; several premium portfolios available.

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SoFi Automated Investing — Low costs, great perks

SoFi
SoFi Automated Investing’s 0.00% management fee and ultra-low 0.08% average expense ratio makes it one of the most competitively-priced robo-advisors in the market. Valuable perks come with opening a SoFi account, including free access to SoFi financial advisors, free career counseling and discounts on loans.

Automated Investing’s main downside is that their portfolios are less customizable than its peers’, with only five different risk levels to choose from, as opposed to at least 10 available from others. SoFi does not offer tax loss harvesting yet, though this may change in the near future.

SoFi Automated Investing’s key attributes:

  • Fees: Zero management fee, plus 0.08% avg expense ratio.
  • Minimum starting deposit: $1
  • Investing strategy: All SoFi Automated Investing portfolios are actively managed. This means that real humans at SoFi decide the makeup of the five model portfolios, which they believe will add value beyond what passive investing offers. SoFi invests your money in one of five portfolios of low-cost ETFs, covering 16 different asset classes. Each of the five portfolios has two versions: one is for taxable accounts and the other for tax-deferred or tax-free accounts, like IRAs and Roth IRAs. SoFi only rebalances portfolios monthly, versus some peers which check for this opportunity daily.
  • Average annual return over five years: 6.78% per year on the moderate risk portfolio (60% stocks / 40% bonds).
  • Other notable features: Commission-free stock trades in separate Active Investing accounts. SoFi’s combined checking/savings product, SoFi Money, offers 1.10% APY on deposits. Customers must open this account separately.

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SigFig — Free access to advisors

SigFig
Free access to financial advisors by phone and 0.00% management fees on the first $10,000 deposited are SigFig’s biggest strong points. On deposits over $10,000, management fees rise to 0.25%. Expense ratios are on the high side compared to the competition, at an average of 0.15%.

One of SigFig’s peculiarities is that they do not hold your assets. If you open a new account, SigFig will open an account at TD Ameritrade for you and then manage it. Current TD Ameritrade, Fidelity and Charles Schwab customers can also use SigFig’s robo-advisor services.

The $2,000 minimum deposit may put SigFig out of reach for some, but SigFig is worth a look for investors looking to keep robo-advisor costs low.

SigFig’s key attributes:

  • Fees: Zero annual management fee for the first $10,000; management fee rises to 0.25% of assets on balances over $10,000. Average ETF expense ratio of 0.15%, depending on allocation.
  • Minimum starting deposit: $2,000
  • Investing strategy: SigFig invests your money in an automated portfolio based on how you indicate you want to invest. Each portfolio is made of ETFs from Vanguard, iShares and Schwab, comprising stocks and bonds in nine different asset classes. The specific ETFs SigFig invests in will vary based on whether your account is held at TD Ameritrade, Fidelity, or Schwab.
  • Average annual return over five years: 5.45% per year for moderate portfolio (as of 4/24/2019)
    Other notable features: SigFig has a free portfolio tracker that allows investors to track their entire portfolio’s performance across multiple brokers.

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WiseBanyan — No-frills choice for beginners

WiseBanyan
A 0.00% management fee for core robo-advisor functionality makes WiseBanyan a good choice for beginning investors who can get by with a no-frills offering. Make sure to notice that they still charge a 0.12% average ETF expense ratio, so it is not completely free.

WiseBanyan charges premiums for features that come standard with other robo-advisors, including tax loss harvesting (0.24% of assets up to $20/month max), expanded investment options ($3/month) and auto-deposit ($2/month). If you care about these other features, do the math based on your own portfolio size to compare WiseBanyan to its peers.

WiseBanyan’s key attributes:

  • Fees: Zero management fee, plus average ETF expense ratio of 0.12%. Premium features carry additional fees and higher expense ratios.
  • Minimum starting deposit: $1
  • How WiseBanyan invests your money: For basic Core Portfolio users, portfolios comprise ETFs across nine asset classes, with an average expense ratio of 0.03% to 0.69%. If you upgrade to the Portfolio Plus Package, you gain access to 31 total asset classes with exposure to ETFs tracking oil and gas, precious metals and other industries, with an average expense ratio of 0.03% to 0.75%.
  • Average annual return over five years: Not provided
  • Other notable features: Premium offerings, including tax loss harvesting (0.24% /month up to $20/month max), Fast Money auto-deposit ($2/month) and Portfolio Plus ($3/month).

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Acorns — Unique savings functionality

Acorns
By rounding up the spare change from your transactions and placing it into an investment account, Acorns provides a clever way to get started with investing. The main drawback is that, until you have more than $4,800 deposited in an Acorns Core account, the $1/month fee will actually be proportionally higher than the 0.25% management fees that most competitors charge.

Acorns does not offer tax loss harvesting, joint accounts, or access to financial advisors currently. Still, if you’re looking for an easy way to start investing, give Acorns a shot.

Key attributes of Acorns:

  • Fees: $1/month for Acorns Core, plus ETF expense ratios ranging from 0.03% to 0.15%
  • Minimum starting deposit: $5
  • How Acorns invests your money: Acorns invests your money in one of five automated portfolios— notably, this is a more limited number of portfolios than some other competitors. Each portfolio comprises ETFs across seven asset classes.
  • Average annual return over past five years: Not provided
  • Other notable features: Offers two add-on accounts for expanded functionality with Acorns Later retirement product ($2/month) and Acorns Spend checking account ($3/month).

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What is a robo-advisor?

A robo-advisor is a service that uses computer algorithms to invest customers’ money in portfolios customized to their needs. Since robo-advisors create these portfolios using automated algorithms, they can charge a fraction of what human advisors do and still offer advanced benefits like auto-rebalancing and tax-loss harvesting to boost overall returns. Most robo-advisors start with a questionnaire to assess your financial goals, risk tolerance and assets. Based on the answers, the robo-advisor allocates your investments accordingly.

How do I choose the right robo-advisor?

When considering which robo-advisor to choose, you should focus on management fees, minimum balances, ease of use and customer support. The lower the fees, the more money stays in your account. The top robo-advisors typically charge a flat management fee of 0.00% to 0.50% of your deposited balance. In addition, you pay an expense ratio to cover the fees charged by the companies offering the ETFs that comprise your investment portfolio. Note that some robo-advisors claim to offer zero management fees, but still charge an expense ratio.

Make sure you are comfortable leaving your deposits with a robo-advisor for the medium to long term — think five to eight years. There are a number of robo-advisors with $0 account minimums and most are under $5,000 today.

How do I open a robo-advisor account?

Most robo-advisors can have you up and running with an account in a few minutes. Typically you create a username, fill out a questionnaire to assess your financial goals and risk tolerance and connect your profile to a bank account. There may be some additional steps required for verification depending on the robo-advisor.

What other features should I consider?

Robo-advisors offer a host of additional features, including tax loss harvesting, cash management options, checking accounts and rewards programs. Cash management can provide a meaningful compliment for users who keep some of their portfolio in cash. Some robo-advisors offer an APY of more than 2.00% on cash management accounts. Tax loss harvesting can make a difference for users looking to lower tax exposure.

What is tax loss harvesting?

Tax loss harvesting is a tax strategy that some robo-advisors offer to help clients reduce their tax bill. Generally, this involves selling an asset that has lost value for a loss, using that loss to offset capital gains taxes or income taxes, then purchasing a similar but not “substantially identical” asset to maintain exposure to the asset class. The details behind each robo-advisor’s strategy can get complicated and should be looked at in detail to make sure you understand what you are getting into.

Capital losses from tax loss harvesting can be used to offset capital gains and can potentially offset up to $3,000 (or $1,500 if married and filing separately) of ordinary income.

What if my robo-advisor goes out of business?

While not a pleasant thought, it is possible that a robo-advisor could go out of business. Most robo-advisors insure clients’ assets through the Securities Investor Protection Corporation (SIPC). This is different from the bank account coverage provided by the FDIC; generally, SIPC coverage includes up to $500,000 in protection per separate account type, with up to $250,000 of cash assets protected.

Keep in mind that the SIPC will take necessary steps to return securities and account holdings to impacted clients, but will not protect against any rise or fall in value of those holdings. This means that if you make a bad investment in a stock, the SIPC ensures you still own that bad stock, but do not replace losses from a poor investment. Some brokers also insure assets beyond the $500,000 in SIPC coverage through “excess of SIPC” insurance.

See the full list of SIPC members at their site, along with a detailed explanation of how SIPC coverage works.

The bottom line

Robo-advisors can be an excellent option for users who are starting their investing journeys, rolling over a 401(k) or who want to minimize the time needed to manage their investments. By creating a customized portfolio based on your financial goals and automatically rebalancing your account, a robo-advisor can help to maximize your return while taking on the right amount of risk.

Because robo-advisors run off of automated algorithms, you should be comfortable with little or no human touch for your investments. The upshot to low human interaction is that fees are generally much lower than with a registered investment advisor, which may be worth the tradeoff as part of an overall financial plan.

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