Which Robo Advisor For My Teen?

Start talking with your kids about investing their own money.

My husband and I recently sat down with our son, 13 years old and newly flush with bar mitzvah money. It wasn't long before someone mentioned the robo advisor—the new breed of automated, online asset allocation and investment management services that offer all-ETF portfolios.

These services offer cheap asset allocation and fund selection, with rebalancing, tax-loss harvesting and other services. Some are even completely free. Why not recommend this cutting-edge solution to our 13-year-old young adult?

Because I don't make any investment recommendations, no matter how small the pile of money, before I've done my due diligence. Tag, I'm it.

Existing robo-advisor media coverage hasn't been very helpful in terms of due diligence. So far most of the chatter has been around their disruptive business model, focusing on questions like whether robo advisors will drive human advisors out of business.

But what about the thing that matters most over the long term—the actual portfolio? Really, that's what drives long-term returns. And for a 13-year-old, the long term could be very long indeed.

Asset allocation, fund selection and portfolio maintenance are the heart and soul of investing. Get it right, and you'll have a comfy retirement—if you save diligently. Get it wrong—or fail to save enough—and you'll be eating cat food, as Bill Bernstein pointed out in a recent interview on ETF.com. Your investment selection can make the difference between community college and Stanford.

So I asked six ETF-only robo-advisor firms to send me two portfolios each: a very aggressive 90 percent equity/10 percent fixed-income allocation, and a more traditional 60/40 split.

I explained to each firm's chief executive officer or chief investment officer my intent: to use ETF.com's ETF Analytics tools to analyze and compare each of these portfolios in order to help investors understand the risks, rewards and philosophies of each, and to choose the one most appropriate for them.

The 90 percent equity portfolio—from any of the six—would be suitable for investors who prefer to manage their fixed-income separately. Residents of California, New York and New Jersey won't find robo portfolios offering state-specific municipal bond funds—not yet.

Anyway, I dare say, my bar mitzvah boy probably doesn't need fixed-income exposure. Not in middle school, anyway.

The 60 percent equity portfolio fits the classic "moderate risk" allocation. Many of us old fogies will appreciate a peek under the hood of the fixed-income suite, and a gander at a less edgy equity allocation.

I could have asked my son to test drive each firm's social-worker bot with its income surveys and risk-assessment software, and then analyze the resulting portfolios. But I worried that I would never know whether the differences would be attributable to the firms' investment philosophies, their risk assessment tools or to teenage mood swings. So I opted to keep the equity weights consistent, and see how the portfolios compared with each other.

Put another way, I said, "I'm sorry, Dave, I'm afraid I can't do that," to an evaluation of the risk assessment bots. It's an important point. I didn't ask each advisor for their "risky" and "moderate" portfolio, so we're not evaluating anyone's version of what "moderate" means.

Of course, robots have no heart. They're automatons. Wouldn't you expect them to produce highly similar portfolios when given a "90 percent equity" mandate, regardless of whether they come from Wealthfront, Betterment or upstart WiseBanyan? Hardly.

Check out this table showing the differences in price-earnings multiples (P/E ratios), emerging market allocations and financials exposure among these six 90/10 robo-advisor portfolios.

Portfolio analysis as of July 1, 2014, using firm-supplied equity weights in 90 percent equity portfolios and ETF.com's ETF Analytics data and portfolio analytics tool.

In its aggressive 90 percent equity portfolio, Wealthfront allocates 25 percent of its equity position to emerging markets, while WiseBanyan allows a mere 6 percent. Allocations to real estate tip the financials sector's weight in the aggressive portfolios to 28 percent at Covestor, and a whopping 36 percent at FutureAdvisor. Portfolio P/E ratios—as measured using trailing 12-month earnings—range from 17.8 at Wealthfront to 20.9 at Invessence.

The 60/40 portfolios generally showed the same contrasts, though a home-country bias within equities popped up in Wealthfront, WiseBanyan and Invessence's moderate portfolios, with Invessence allocating 80 percent of its equity exposure to U.S. firms.

The fixed-income portfolios ranged from the timid to the bold, as you can see in this overview of the fixed-income portion of the 60/40 portfolios.

Portfolio analysis as of June 30, 2014, using firm-supplied fixed-income weights in 60% equity portfolios and ETF.com's ETF Analytics data and portfolio analytics tool.

Average durations run as low as 4.25 (FutureAdvisor) and as high as 8.60 (Invessence); credit spreads were as low as 2.06 and as high as 7.56 (same as above).

Yields are not as comparable because Wealthfront, Betterment and Invessence offered tax-sensitive portfolios with munis, while Covestor, WiseBanyan and FutureAdvisor currently offer only taxable bonds.

Betterment, FutureAdvisor and, to a minor extent, Invessence, offered non-U.S. bond exposure.

Robo portfolios turn out to be as different as R2-D2 and C-3PO. No two are exactly alike, because they've been programmed by humans—humans with opinions about asset allocation, security selection and portfolio maintenance. The resulting portfolios reflect their makers' convictions.

It's important to understand that none of these 90/10 and 60/40 portfolios is necessarily "right" or "wrong," and they might not represent the typical client at any of the automated online asset-allocation firms, especially those marketing to Silicon Valley's forever-young 20-somethings.

But they're useful anchor points for an exploration of each robo advisor's philosophy.

I'll be writing seven blogs about this relatively new industry within an industry: this piece, plus six more, all focused on exploring the differences in the robo portfolios.

Next time, I'll introduce the robo advisor lineup and give an overview of how each firm approaches investing and portfolio construction. In blog three, I'll open up each portfolio, and analyze the exposures they offer. Blogs four and five will focus ETF.com's expertise in ETF analysis to the robo advisor's ETF selection process, blog six will take a deep dive into the value of tax-loss harvesting. Blog seven brings in all home with our robo-pick.

Contact Elisabeth Kashner, CFA, at [email protected].