When it comes to investing in equities, its always best to have a long time horizon (as short term is best suited for traders and not investors).
And since there are tons of research on how expenses play a major role in your long term returns, it goes without saying that the debate of active vs passive is witnessing more and more support on the side of the passive investing.
Now there are two approaches on the passive side of the discussion as well.
What are they?
- Passive DIY (Do-It-Yourself), or
- Invest via Robo-Advisors
Many investors who invest for the long term are not sure whether to go for Robo-Advisors Or do it the DIY way.
To be fair, both have their pros and cons. But we will get to those in a bit.
Which path you choose to invest for the long term should be a well-thought-out decision after weighing various factors.
Among a few important ones is your investment experience (or expertise). No point going DIY when you are not even sure whether your investment acumen is there or not. Right? It’s glamorous to by DIY and invest on your own. But to be fair, investments are not just about picking between active and passive funds. It is also about knowing about asset allocation, risk profile, market’s dynamic and several other things. The decision also depends on your unique situation, requirements and financial goals.
But before we move to a more detailed discussion on the Passive DIY or Robo Advisors, let me say this up front that no matter what one believes in, the fact is that there is no alternative to good investment advice.
And good investment advice can be the difference between meeting and missing your financial goals. There are no 2 ways about it.
So let’s move on. Several Robo-advisors are already operational and new ones are getting born now and then. But are you better off investing on your own (DIY) or by going with these digital investment advisors?
What is Passive DIY Investing?
DIY stands for Do-It-Yourself. So basically, you invest on your own. Or as some like to call it, self-directed investing. But whatever you call it, it’s simply about managing your investments and portfolio on your own.
And by definition, you are yourself responsible for picking and managing the products / asset classes you invest in. You will have to do your own research, evaluate the pros and the cons and then make investment decisions.
Now Passive stands for investing in passively managed index funds / ETFs. The idea is to simply pick products that aim to match market returns.
So when you take your investment decisions and manage your long term investment portfolio using passive funds and ETFs, then that is referred to as Passive DIY investing. The most common scenario will be something like this – You pick your asset allocation based on your risk appetite and time horizon. You invest in a few index mutual funds or ETFs. Monitor the portfolio asset allocation regularly. And when asset allocation changes beyond a threshold, you rebalance it back to the originally chosen allocation periodically (generally once or twice a year. That’s it.
Note – Index funds and ETFs are passive investment tools that are structured to simply track the performance of some market index Nifty50, S&P500, etc. These are considered to be well-diversified and a good choice to get sufficient market coverage.
That is about Passive DIY investing. Let’s see what these robo advisors are and how they work.
What are Robo Advisors and How do they work?
I would say first of all that the nomenclature itself is very interesting and immediately pushes one to visualize a metallic humanoid. 🙂
But jokes apart, Robo Advisors doesn’t mean the absence of humans. It definitely has a human component that devises the algorithm used by these tools. And it may not be wrong to say that the term ‘robo’ here is to emphasize the investments are managed by algorithms in an auto-pilot manner but supervised by human investment advisors.
So basically, these Robo Advisors are online portals or automated tools where one provides his/her personal and financial details and according to that, the algo-driven system will churn out an investment plan.
But all robo-advisors are not alike. They come in a wide variety of shapes and sizes. Some robo advisors only use passive index funds and ETFs while many others use actively managed funds. Then there can be those which use a combination of both passive and active investments.
There can be different approaches but more often than not, most robo advisors use algorithms that are based on the Modern Portfolio Theory and Efficient Market Hypothesis.
A typical and mature robo-advisors invest your money in a portfolio of diversified index funds or ETFs in line with your risk appetite and time horizon of the financial goal you are targeting. The algo-driven platform then periodically rebalances the portfolio back to the originally chosen asset allocation.
Now let’s have a look at the pros and cons of both these approaches, i.e. first DIY Passive Investing and then Robo Advisors, before deciding which approach is suitable for whom?
Pros and Cons of Passive Index Investing
Passive DIY investing seems easy to most. And its no doubt simple. As a common example, it’s simply about choosing your preferred asset allocation (between various assets) and then invest in passive funds / ETFs in line with the chosen allocation. Since market movements will change the allocation over time, just make sure to rebalance once a year to bring it back to the chosen allocation. But one possible problem is that people allow their emotions to influence them. So whether the DIY investors continue to follow this process for long enough on their own without any handholding or not is another question. Some people can do it as they have the necessary discipline. But many others can’t as they don’t have the necessary self-control.
Since investments happen in passive instruments, the costs (and fees) are extremely low. This is the biggest benefit of passive investing.
Then another added advantage is that there is no need to find a different fund or ETF each year due to under performance. Index funds and ETFs simply follow the market and hence, there is no question of under or over performance.
For smaller portfolios, DIY passive investing is very easy to implement. But if the portfolio is large then it might take some time to implement the DIY approach as its possible that people with large networth following passive DIY will be having their investments spread across a variety of accounts.
Pros and Cons of Robo-Advisors
The very first advantage that Robo-Advisors offer is that being driven by algorithms, they are able to take decisions without getting emotionally involved. So for someone who doesn’t have the emotional discipline and is influenced by market volatility, Robo-Advisors can help as they remove the emotions out of buying and selling decisions.
Another advantage is that things are simple. There is less hassle as a Robo-Advisor can act as a one-stop solution for asset allocation, fund selection, etc.
But different Robo-Advisors offer different products. So it’s possible that the asset class you want exposure to may not be available via the Robo Advisor. Let’s say you want to invest in a REIT. Then it’s possible that your robo-advisor’s portfolio may not have access to that asset class. So at times, investing via Robo-Advisors can limit the choices available to you. But still, Robo-Advisors can deliver sufficiently well on the requirements of a vast majority of small investors.
Many Robo-Advisors invest via passively managed Index Funds and ETFs. So along with the ease that they offer, the costs can also be controlled if the platform is investing in passive products. But Robo-advisors also charge small fees to handle your account which is lower compared to traditional investment managers.
So if you compare the costs of DIY investing vs Robo-Advisors, the DIY is cheaper no doubt. But Robo Advisor platforms offer ease-of-use as well as other features like automated rebalancing and tax-loss harvesting which may not be easily possible for most DIY investors.
So when weighing the options and comparing the value being offered by both modes of investing, you should take into consideration every feature that is available or not available and what is applicable and not applicable to you.
Choosing Between Robo Advisors Vs Passive DIY
For starters, if you are new to investing and don’t know much about how to invest correctly, then robo-advisor platforms can be a great way to begin.
What happens in a typical scenario is that when you enroll in the platform, you will start by taking a risk profiling questionnaire that will help figure out your risk appetite. Some information about your financial goals and time horizon will be collected. Then based on these inputs, the robo-advisor will then create your investment portfolio.
There are several Robo Advisors like Questrade and Wealthsimple that offer pre-made portfolios for different types of investors. Both Wealthsimple robo vs Questrade DYI brokerage are good but offer distinct options for investing in developed markets. So one should check the features of each and then decide after proper comparison.
Once on-boarded on these tools, you don’t have to go about select investments or funds or trying to maintain allocation via periodic rebalancing or dividend reinvesting. The algorithm of the robo-advisor handles all that for you very easily and in the background. The only job you the investor has to fund the account. The robo platform will do the rest.
But are robo platforms only good for new investors?
No, even those investors can use these tools who already have a good knowledge about investments. Maybe you already know how to invest your money properly. But you are just so busy with your life that you don’t have the time to give to managing your investments. If that’s the case, then robo-advisors can be the perfect investment platforms for you.
And robo advisors are constantly evolving and adding new features as per investor needs and market changes.
But if you are one who wants to involve yourself with each and every decision related to your investment portfolio and you are looking to beat the markets (and not just earn market returns using passive ETFs), then you are better off being a DIY investor. But just wanting to be a DIY investor isn’t enough. You should be very careful about how you judge your investment skills as your performance will depend on it.
Having said that, there is another way to invest.
And that is by taking investment advice from human advisors.
A traditional human investment advisor will score more on the personal touch and the face-to-face reassurance that is on offer in times of need. In many cases, an investor’s unique situation and requirement may demand a customized portfolio approach that can only be delivered via human advisors. No doubt robo-advisers are cheap compared to human investment advisors. But if someone doesn’t fit the limited options on offer via the platform, then a personal financial adviser can help tailor their services for investor’s unique needs.
But coming back to two options in question, the fact is that it’s not exactly about Passive DIY Vs. Robo Advisors. It can very well be about Passive DIY AND Robo Advisors.
So initially, one can start with both approaches simultaneously. That is, you can choose to have a manage a portion of your assets via robo-advisor and the rest yourself, i.e. DIY. And then over a period of time decide which is working best and then shift to that approach completely.
By the way, if you are confused between choosing the two, then don’t let that dilemma result in you not invest at all.
Remember that the biggest mistake you can really make in all this is ending up with not investing at all!
Whatever approach you pick, just pick one and start first. Don’t procrastinate. Over time, you can make course corrections and decide which is working best for you. When it comes to choosing between passive DIY investing vs. robo-advisor, remember that it’s ok to change your mind. Just start with one, and if it doesn’t seem like the right fit, then move your money to the other approach. Plain and simple.
But as we conclude, it must be said that ours is a lucky generation. Earlier, good quality financial advice was available only for large and sophisticated investors. But with robo-advisors and the spread of technology, good investment advice is available for everyone!