About me

I am Henry Bowers, I graduated from CUNY Baruch College, Zicklin School of Business with a Bachelor of Business Administration in Finance & Investments. I have always had an interest in learning data science for finance to make better-informed investment decisions. After taking online courses through Data Camp and reading many articles on R for finance. I decided to take a capstone course in financial econometrics, which was my favorite college course. Throughout the class, I learned even more about risk management and data visualization of time series. I have a growing passion for understanding data science for finance and applying those skills to make better-informed investment decisions for my portfolio using computational investment strategies with R programming. Skills I developed include multi-asset portfolio construction, optimization, risk management, and volatility modeling.

Linkedin: https://www.linkedin.com/in/henry-bowers/

Introduction

Starting your financial journey by investing is a big step for most people and could be a very risky one if they don’t know much about financial markets. Thankfully, today, we have Robo advisors who typically construct model portfolios based on users’ different levels of risk consisting of low-cost ETFs. In this research, I will be comparing the model portfolios of the most reviewed Robo-advisors, which are Wealthfront, Betterment, and M1 Finance. At the end of this research, the User would be able to see which Robo-advisor has the better-performing model portfolios.

Disclosures

Data gathered for research has been downloaded from Yahoo Finance API. Historical returns are also not predictors of future performance. This is not a recommendation to buy or sell any security mention. Opinions written here are of my own and not of my current employer.

Comparing Retirement Account Model Portfolios

Throughout this post, I will be looking at their most aggressive portfolios, primarily for individuals who are just starting their investment journey with a +20 year time horizon

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Regarding the most aggressive portfolio, if an investor had a high-risk tolerance and wanted a more hands-off approach based on the data shown above Wealthfront’s most aggressive portfolio generated the highest rate of return, however it is important to note that Wealthfront and betterment performance is fairly very similar and both Robo Advisors have a 0.25% AUM fee for their clients. In the next session, I will cover Monthly returns and the effects of AUM-based fees.

Monthly Returns

As investors, it is important that when we are deciding what funds to pick or even what Robo advisors we are picking to invest our money for us, we should understand the risk associated and ask ourselves what strategies these Robo advisors are doing differently.

Let’s look at the portfolio construction of Betterment, consisting of 8 low-cost ETFs, 90% being equities and 10% bonds. Their equities are spread out between multiple ETFs covering large, mid, and small caps. Now the question is why they wouldn’t just choose an ETF that already covers all 3 of those areas, such as VTI or ITOT, which are both US total equity ETFs. By separating these ETFs, they are able to capture the growth of these sectors in hopes of achieving better returns during economic change. For example, small-cap stocks, which are young growth companies, have a higher possibility of outperforming in the short term during economic rebounds when we see large changes driven by our politicians. Since young growth companies are typically riskier and more filled with debt. These companies become naturally more sensitive to interest rate movements; therefore, when the FED decides to cut rates, which will lower borrowing cost for these small-cap stocks. We would be able to see a jump in their performance.

As I’m writing this, SPSM (SPDR Portfolio S&P 600 Small Cap ETF) jumped nearly 4% in the last six months. However, VTI jumped around 10% within the same timeframe. So why bother having a small cap sector exposure? Is it worth it? I do not see the point, and if anything, by sticking to VTI or ITOT, you are getting exposure to everything you could need. Yes, although these are market cap weighted structured ETFs, just sticking to one fund that tracks the entire equity market will make the portfolio structure simpler, and simplicity is the key to financial freedom. Investing shouldn’t be complicated. Because what differs from Wealthfront and Betterment, although returns are closely related, Wealthfront majority leads against Betterment due to its exposure of having a higher weight towards VTI which gives Wealthfront the ability to capture all growth cycles without needing to choose a concentrated area.

Risk Measures

Although these portfolios have differences in their portfolio construction, the overall risk measures relatively follow in the same trend. Therefore, the next step would be to find the portfolio that has the most amount of risk and least return. Based on the risk measure charts above, the M1 Finance model portfolio has the most spikes in 30-day standard deviation and 30-day Value at risk and lags on the sharp ratio performance as well. Let’s dig into their portfolio construction.

We can see here that most of the M1 Finance model portfolio consists of VEA. It is honestly shocking to see because this fund has a focus on European and Pacific markets (over 80% of the ETFs holdings are within this region). In the last six months, the fund is only up 1.4%, recovering from a drop due to global political tensions. With exposure to international holdings, there is a lot more risk involved. Considerably political risk revolving around international trade deals and foreign economies. If these foreign economies don’t perform well, then these international holdings will be greatly effective as well, causing a decrease in the fund’s performance. Considering that VEA is just about 50% European holdings, whatever happens to the European economy will have more of an impact on their holdings. The European economy is mostly driven by two nations, Germany, and France, two countries that are both going through political changes as well. Since M1 Finance’s largest holding is in VEA, which is dragging the returns that they could be making, let’s look at Germany’s and France’s GDP growth. For the charts below, I will source the data from FRED.

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From here, we can sadly see that since the COVID global recession, both the French and German GDPs have had a hard time recovering. Based on their growth, they are on a declining trend, which won’t be very good for VEA performance either. The declining growth of these two GDPs will affect the equity market of VEAs’ respected holdings. M1 Finance should instead have VTI as the majority holding instead of VEA, which will also replace their holding of the mid and small-caps ETFs. And if they have VTI, there would be no need for having VOO either since owning VTI gives you exposure to the whole equity market and allows for more diversification. I believe it is essential to have some international exposure in your portfolio; however, not more than 10% unless you are extremely bullish on foreign economies could end up giving you a better return than US equities.

By now, as an investor with all the information above comparing the returns and risk measures of the most reviewed model portfolios. It comes down to mainly two portfolios, and that is the Betterment and Wealthfront. Both brokers charge a 0.25% annual AUM fee. Well Betterment charges 4 dollars per month up until you have a 20k portfolio value than its 0.25% AUM, which is relatively still the same amount you were paying before (20k*0.25% /12 = 4.17). Even though these fees can be less than your typical Soundcloud / Spotify subscription, I just don’t see the point of paying another 4 dollars a month, just as if it’s another subscription. Investing our hard-earned money should be free of charge, hence why I use fidelity. These monthly AUM fees can delay your snowball effect on dividends as well, which hasn’t talked about much either. So, if an investor would need to use a robot advisor, Wealthfront is the winner in my eyes as it had the better performing portfolio regarding risk measures. and the overall interface of the wealth front platform is very well put together.

           Betterment Wealthfront
2024-09-30   5.044412    5.138945
2024-10-31   4.927183    5.022524
2024-11-30   5.114267    5.189915
2024-12-31   4.957446    5.039691
2025-01-31   5.096247    5.182348
2025-02-28   5.178372    5.280795

As your portfolio value increases or decreases, the fee will change. However, as investors, we want our portfolios to rise in value over time; therefore, using a platform that charges fees based on AUM will only result in higher fees. To be fair, Wealthfront does an excellent job of showing how much your fee would be each month based on hypothetical future portfolio values. Still, I just don’t see the full value of paying another service to manage money when an investor could easily follow a simple strategy and just rebalance annually.

The Three Fund Porfolio

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Investing does not need to be overly complicated with all these Robo advisors within the market. An investor could easily outperform the Robo-advisors platform over the long term by just investing into VTI, VEU, and BND. By doing this, an investor could save on hundreds of annual fees in the future. Hope this post was informative. More research to come.