Category: Financial Management

The Online Advisor for Silicon Valley Might Be Right For You – Wealthfront Review

Executive Summary of Wealthfront Updated for 2015

Wealthfront is an  online investment advisor that now manages over $1 billion in assets, hitting the mark in only two and half years. Their growth model was focused on young tech employees in Silicon Valley who had stock options and no knowledge of what to do with their wealth. They use ETFs to create a portfolio based on your risk profile and investment needs and then invest on your behalf. Their fees are a fraction of the price of a traditional brick-and-mortar investment advisor. By targeting their product to the high-tech subset of the general population, they have created something that everyone will appreciate. It is easy to use, intuitive, and very clean from a design standpoint. Their investment methodology is outstanding as well, as you would expect the best personal finance software to be. Wealthfront charges an advisory fee of 0.25%.

Overview of Methodology

Wealthfront utilizes Modern Portfolio Theory (“MPT”) to help investors create a personalized risk adjusted portfolio based on their investing horizon, appetite for risk, and portfolio size. Diversification and strict reallocation ensure that your money is utilized in the best way possible. This methodology is utilized by wealth advisors and investment professionals worldwide to provide the best possible return with the lowest desired risk. Their proprietary software will reallocate your portfolio to ensure that you maintain the needed balance to maximize returns. Their whitepaper on their investment methodology says:

“Prior to the launch of the Wealthfront Online Financial Advisor, it was not practical to offer MPT to everyone because delivering a complete solution was too complex. Specifically, the effort required to optimize an asset allocation, the identification of the ideal securities to represent each asset class and the identification of an individual’s true risk tolerance has been beyond the scope of free, web-based tools.”

Setting Up Your Wealthfront Portfolio

Setting up a portfolio with Wealthfront is a simple process.

Wealthfront Subjective Risk Tolerance Question

First, investors are asked a series of questions to test their risk tolerance from a subjective standpoint and from an objective standpoint. I was asked questions about what I would be willing to lose in certain situations as well as my age, after-tax income, and amount ready to invest. The former are the subjective risk tolerance questions and the latter are the objective risk tolerance questions.

Next, you are presented an Investing Plan that tells you what to invest in, the percentage of your total investment to allocate to a given security, and the dollar amount to spend on each investment. Wealthfront relies primarily on ETFs for investment. They do this to capture broad markets and also because the ETF expenses are lower than mutual fund expenses. The company does not receive compensation for recommending ETFs from specific companies. I find it reassuring that there is no additional commission coming to Wealthfront when I purchase the securities. Their recommendations are unbiased and based on a survey of thousands of ETFs. Know that if they recommend 10 Vanguard ETFs, it’s because those are the best available. Wealthfront requires that you have only $500 to invest, but their fee structure makes it very affordable for investors getting an early start on building wealth.


Wealthfront Advisory Fees

Wealthfront’s fee structure is easy to understand. They charge a monthly advisory fee based on an annual rate of 0.25% of assets under management during the month.

Here is an example provided by Wealthfront:

Jane invests $50,000 in a diversified portfolio on Wealthfront. Jane begins investing on April 5th and invests through the end of April, for a total of 26 days. Wealthfront’s annual fee rate is 0.25 percent. To simplify this example, we will assume that the net market value of Jane’s assets remains $50,000 for every day in the month of April. Therefore, Jane’s advisory fee for the month of April equals: (0.25% / 365) * (the net market value of managed assets greater than $25,000) for every day on which the assets were managed = (0.25% / 365) * $25,000 * 26 = $4.45.

How Much Are Wealthfront’s Brokerage Fees

In addition to their advisory fee, you’ll have to pay third party fees on the ETFs and broker commissions, which will vary for each customer. The ETF fee will probably be in the 0.15% – 0.20% per year range and the commissions are not fully disclosed but in the sample portfolio that I put together, Wealthfront estimated that the commissions would be $1.12 on a $15,000 investment, $3.20 on a $50,000 investment, and $7.56 on a $100,000 investment. Very nominal commissions. You’ll pay additional broker commissions when Wealthfront rebalances your portfolio. The rebalancing is an automatic process that ensures that you maintain the correct investment mix. Your portfolio will naturally drift from the optimal balance as certain indexes and markets out perform others. Studies show that rebalancing could add up to 0.4% per year over ten years. Wealthfront also considers the tax implications and commission costs when rebalancing.

Is Wealthfront a Broker?

Wealthfront utilizes a company called Apex Clearing Corporation as its brokerage partner. You are the only one who can deposit or withdraw money into your account (except for the advisory fee charge).

After opening the account, you will purchase the securities. You can also start an IRA (Traditional, Roth, or SEP) or rollover your 401k. The focus for Wealthfront is simplifying the investment process. They do it very well.

Should I Open An Account With Wealthfront?

I highly recommend Wealthfront. It’s easy to use and has a great team of advisors. Whether you are starting on your personal financial journey, or well on your way, you’ll enjoy Wealthfront’s low fees and great service. This should appeal to anyone looking for a DIY approach to financial management. Wealthfront is ready to replace your financial adviser’s high fees with world-class financial management for a fraction of the cost. Wealthfront might not be right for you if you are looking for more hand-holding or want to speak with a traditional advisor. While you can pull your Wealthfront account information into Mint, Wealthfront does not take into account investments in outside 401k plans or IRAs.

Wealthfront vs Personal Capital

Wealthfront is different from Personal Capital in that you don’t have an individual advisor assigned to you. Furthermore, Personal Capital allows you to see all of your accounts in one place so if you have a few different IRAs and 401k plans, you may want to look at Personal Capital. The other difference is in the fees. Wealthfront is 0.25% whereas Personal Capital has a graduated scale and your first $1 million is 0.89%. If you need more hand-holding, go with Personal Capital (see my full review here).

Whole Life Insurance and The Infinite Banking Scam

Is infinite banking a scam? If you consider permanent life insurance to be a scam, then it’s a scam. I don’t, but I know that some do.

While I don’t think it’s a scam, it can feel that way for a few reasons, not least of which is the pushy salespeople.

The Be Your Own Banker, Infinite Banking, and Bank On Yourself methodologies have been around for a long time because they are whole life insurance policies marketed as financing and banking tools. The real question to ask is whether you should purchase permanent life insurance. Generally, you should simply purchase term insurance.

Permanent life insurance should not be your first “investment” and is best suited for those looking for additional ways to pass money to their heirs or for those who need permanent insurance due to age. It’s an estate planning tool or a way to get life insurance if you are past the age where term insurance is a viable option. Be Your Own Banker  / Infinite Banking looks to turn permanent life insurance into a retirement plan and perhaps a means of financing major purchases. I recently sat through a series of meetings with a Be Your Own Banker life insurance broker to understand what it is all about and if I could use it to finance a major purchase that would require a bank loan.

The basic concept in Infinite Banking is that you would fund a whole life insurance policy and use the cash value of the policy purchase permanent life insurance and tack on a paid up additions rider. This allows you to borrow against the cash value of the policy. In theory you could then pay off your car loan or use it to finance your business. As a financing vehicle it could potentially be cheaper than getting a loan from a bank. As an investment vehicle, studies show that you are better off putting your money into a balanced portfolio. If you’re not sure how to create one of those on your own check out Personal Capital or MarketRiders and they’ll do it for you. A risk adjusted portfolio will have better returns over time.

I ultimately decided not to purchase the product primarily due to the high up-front cost of purchasing whole life insurance, the 7% fee that would be scraped off the top of my investment, and my personal confidence in earning a return equal to the compound average growth rate of 9.3% by investing in the market.

The counter-argument was that to achieve that tax savings, the lower fees, and guaranteed returns achieved by purchasing whole life insurance were a safer and better investment. One of the main components of achieving that return was the purchase of a paid up additions rider. By adding that rider, the cash value of the policy increases, allowing for better returns.

Major Selling Points

1. Forced savings plan

2. Guaranteed returns

3. Secure financial institutions

4. Interest free loan

5. Tax free withdrawals

Major Drawbacks of Infinite Banking / Permanent Life Insurance

1. Cost – Here’s where I balked. The initial cost is quite prohibitive and the money injected was not accessible for a number of years. Perhaps if the returns were better over time it would’ve been easier to take the bitter pill.

2. Forgoing High Returns in the market. While I understand the calculation, I believe that by investing in a low cost 401k plan with a diversified mix of assets that are rebalanced over time, I can still out perform the projected permanent life insurance.

The returns were our main disagreement. I argued that the average return generated by stocks is about 10% since 1928. The salesman said that we should use the most recent 30 years of data. This actually took the returns higher, but we brought it back down by layering on a crippling management fee of 3.0%. Fees average between 1% and 2% on 401k plans so the 3% was overstated.

The Be Your Own Banker concept (is trademarked!) will appeal to people who do not want any risk.  They’d rather have a fixed return, even if it is potentially lower than what is available on average from the market. Purveyors of the Be Your Own Bank concept run through a series of calculations with you to “prove” that you’re better off putting your money into permanent life insurance than into your 401k. And in many cases they are right. There are a lot of people who do a very poor job of managing their finances. They end up in a 401k with high fees and the wrong asset mix for their age and risk tolerance. In turn, this creates a financial tsunami that buries them when they need their money most!

I had a generally positive experience with the salesman. We disagreed but he was not disagreeable. I can see this concept appealing to some people but would not recommend it unless market risk puts you into a catatonic state or you simply will not ever save unless forced into it. Know that this is not a true savings account and your money is not immediately available. Instead of going with permanent life insurance, embrace some risk and you will see higher returns. Be confident that you are not throwing your money away by putting into your 401k. The life insurance industry calls this strategy, buying term and investing the difference. It’s a good strategy. Automate your savings and work towards specific investing goals (Betterment style investing). You’ll achieve them and end up with higher returns in the long run.

There’s a great discussion over at the White Coat Investor site. The good stuff is in the comments.