UPDATE: 15 Month Performance Review: Betterment vs. Wealthfront vs. S&P500 vs. Other Options + related posts on P2P Lending, High Yield ETFs and other investment strategies

The richest 1% of Americans have access to great financial tools and advice: Firms like Goldman Sachs provide them with (legal) tricks like Tax Loss Harvesting (TLH). Never heard of TLH? Neither had I until my buddy Andrew Dumas, after reading my post titled "Show Me The Money: Six Strategies to Put Your Cash to Work," mentioned a new startup called Weathfront that was on the cutting edge of ETF fund-based portfolio management. This opened a whole new world of investing up to me, which I'd like to share with you.

But first some background: In my past blog post I talked about ETFs, or Exchange Traded Funds, which are a class of funds that create a basket of stocks based on a particular segment of the market. For example, in the past if you wanted to invest in technology companies you basically had two options: You could pick the companies you thought would be the winners, like Google and Yahoo and buy stock in those directly, or you could invest in a mutual fund that has an expert who picks the companies, and you'd pay a management fee for his or her expertise. But ETFs offer a third choice, and it's worth really understanding how they work. Here's a description from Wikipedia:

"ETFs generally provide the easy diversification, low expense ratios, and tax efficiency of index funds, while still maintaining all the features of ordinary stock, such as limit orders, short selling, and options. Because ETFs can be economically acquired, held, and disposed of, some investors invest in ETF shares as a long-term investment for asset allocation purposes, while other investors trade ETF shares frequently to implement market timing investment strategies. Among the advantages of ETFs are the following:

• Lower costs – ETFs generally have lower costs than other investment products because most ETFs are not actively managed and because ETFs are insulated from the costs of having to buy and sell securities to accommodate shareholder purchases and redemptions. ETFs typically have lower marketing, distribution and accounting expenses, and most ETFs do not have 12b-1 fees.

• Buying and selling flexibility – ETFs can be bought and sold at current market prices at any time during the trading day, unlike mutual funds and unit investment trusts, which can only be traded at the end of the trading day. As publicly traded securities, their shares can be purchased on margin and sold short, enabling the use of hedging strategies, and traded using stop orders and limit orders, which allow investors to specify the price points at which they are willing to trade.

• Tax efficiency – ETFs generally generate relatively low capital gains, because they typically have low turnover of their portfolio securities. While this is an advantage they share with other index funds, their tax efficiency is further enhanced because they do not have to sell securities to meet investor redemptions.

• Market exposure and diversification – ETFs provide an economical way to rebalance portfolio allocations and to "equitize" cash by investing it quickly. An index ETF inherently provides diversification across an entire index. ETFs offer exposure to a diverse variety of markets, including broad-based indices, broad-based international and country-specific indices, industry sector-specific indices, bond indices, and commodities.

• Transparency – ETFs, whether index funds or actively managed, have transparent portfolios and are priced at frequent intervals throughout the trading day.

Some of these advantages derive from the status of most ETFs as index funds."

So, ETFs are a great way to place bets on, say, "technology" or "healthcare" if you believe in those industries, or classes of companies like "Large Cap," "Small Cap," "Domestic Market" or "Emerging Market" stocks without having to pick specific stocks.

But back to Dumas' suggestion: There's also another way to get into ETFs -- via two startups that have created an investment management service around ETFs. Think of it as a "financial advisor 2.0," offering much lower fees (as low as 0.15%) than traditional mutual funds. One of these startups is called WealthFront, and the other is called Betterment. My wife and I have put money in both of them, at the same time, and we're going to compare which one is more effective at maximizing wealth, as well as being the most usable of the two. It's the "battle of the automated investment services."

These two services both offer access to things like Tax Loss Harvesting that once was reserved for the richest 1% of Americans. TLH is explained by Betterment here, but at a high level, it basically consists of selling assets that have depreciated in value to create a loss, then re-buying in that same asset class, and using the loss to offset your other gains. Think of it as making the best of a bad situation -- and it typically adds 0.77% to a typical customer’s after-tax returns, annually.

This blog will be a running post with updates as we experience the two services. Let the Games begin! See the comments on this post for running comparisons between the two services.

PS -- as I wrote in my "Show Me The Money" blog, anyone can start investing with as little as $25 -- seriously. Being an investor is a mindset more than anything. So if you don't think you have enough money to start investing, put down that Venti Starbucks Frappuccino, scrape together $25, and get started.

BLOG COMMENTS (from original post):

MNML: Have you all seen this Medium post by Blake Ross (Founder @ Firefox) about Wealthfront?

He really takes them to task.

I was already in the process of moving from Wealthfront to Betterment since it will lower my fees, but now I'm thinking of going straight for Vanguard. Thoughts?

DROdio: That's a fantastic post and really worth considering.

Personally, for now I'll stick with Betterment, largely because I like the idea of betting on a startup that's innovating in the space with lower fees in place than Wealthfront. I also like the idea that with both Betterment and Wealthfront I can make more aggressive bets than just an index fund at-large (i.e., I like that I can tell Betterment my risk profile is "aggressive" and they'll invest in US small caps & emerging markets for me -- something I could do myself if I wanted to actively manage my account, but then again, the whole point is that I don't.) My only real wish is that I could set an "ultra aggressive" stance that would overindex on biotech, small cap, emerging market and technology sectors even more than Betterment does today.

Eric: Here's the deal for those of you debating investment performance over the short term. Check out these three slides that show the asset classes, sectors, and countries with the highest and lowest rate of return in each year over a 20 year period of time. There is absolutely no rhyme or reason. It's just like a roulette wheel. Betterment and Wealthfront have some distinct differences in asset allocation that will likely deliver very different returns inside of 10 years, but over the long haul things are cyclical and they will even out. Both of their portfolio are very good. The last year or two the S&P 500 has ruled and international is the big loser. Small cap U.S. have performed well but relative to international but not as good as large cap U.S. (S&P 500). It will come full circle and each asset class will have their day in the sun, but no one will be able to predict and time it. The guy on here who likes to talk macro economics in hind sight. Well that's great , but you are just as likely to mistime and predict the wrong asset classes, sectors, and countries as you are more likely to mistime things and get much worse performance then if you just stuck with a well-balanced fully diversified world portfolio over the long term rather then trying to time the market and predict macro economic factors and influences on individual asset classes sectors and regions of the world. There are numerous research papers that back me up on this. You guys should check out Charles Schwab's brand-new Intelligent Portfolio service which is pretty much the same thing as betterment and wealthfront but they're charging no asset under management (AUM) fee at all. Schwab is making their money solely on the expense ratios which are just as low as the Vanguard funds that betterment and wealthfront uses and they're also making a little bit of money on the spread they make on the FDIC insured cash portions of each portfolio, just like a regular bank. The only thing I don't like about the Schwab portfolios is they carry a lot more cash than is needed my opinion.

Jeremy: I began investing in April 2014 with both services putting $5,000 in each and immediately saw that Wealthfront was outperforming Betterment. I read tons of blogs and forums on the topic, most of which said that people preferred Betterment, but I just couldn't see why.

For starters:

  1. Wealthfront simply earned more money than Betterment did during the trial period (though I do realize it was short)
  2. Wealthfront's app is so much more detailed and useful than Betterment's
  3. Wealthfront created awesome, interesting and relevant content, while Betterment is overly promotional and doesn't offer as much insight to make me a savvier investor
  4. Betterment has routinely followed in Wealthfront's footsteps from incorporating tax-free muni bonds to tax-loss harvesting. It is very evident that Wealthfront is the innovator in this sphere.
  5. I personally prefer Wealthfront's asset allocation which includes REITs in retirement accounts and skews more towards emerging markets at my risk preference (8.5, I'm 25 years old). I realize this is a long-term play and I believe that there is more future upside in emerging markets than in Europe or Japan.
  6. Wealthfront has better industry connections and more venture capital. This last point can be viewed in another light; over time, the best people will want to work for the best funded companies. VC firms want to know when and how much their returns will be, so if we look at how accounts over 100K at Betterment only pay .15% compared to Wealthfront's .25%, it stands to reason that over time as accounts become worth more and more, Wealthfront will be earning far more money than Betterment will be. This will be viewed as more favorable to VC's and begin cycle that stands to benefit Wealthfront.
  7. Wealthfront's average account size is much larger than Betterment's at something around $90K, so clearly the average investor there does not fear having to pay .10% more at Wealthfront than they would at Betterment.
  8. Lastly, I like the referral model at Wealthfront more which adds real value to users and new investors. Opening an account will allow new investors to try Wealthfront for free for investments up to $15,000 and I also get an additional $5,000 managed for free. This capability alone drastically alters the .25% asset management fee.

DROdio: Jeremy, thanks for your feedback, good to get the perspective of someone who prefers Wealthfront.

Here are the real results for me, so far in the first 7 months:

Betterment: +1.1% return on the $5k. Currently sitting at $5,064.43

Wealthfront: -0.4% return on the $5k. Currently sitting at $4,980.94

Like you mentioned, I don't put much emphasis on short-term tests, as I'm looking at this as a long-term play. But the results are what they are.

Awerkamp: Here is a guide from my course on automated ETF investing, on which account will maximize gains:

Under $5,000 (Taxable Account)-

Invest with Betterment. The cost will be 0.35% APR if you have an auto deposit set-up for at least $100 a month. Otherwise, it will cost $3 cost per month. Wealthfront has a minimum funding requirement of $5,000.

$5,000 - $50,000 (Taxable Account)-

Invest with Wealthfront. They charge 0.00% APR on the first $10,000 invested. Betterment charges 0.35% APR on the first $10,000 invested. Both charge 0.25% after $10,000. This means you will pay $35 less per year on accounts between $10,000-$50,000 if you invest with Wealthfront instead of Betterment.

$50,000+ (Taxable Account)-

Invest with Betterment. They have tax-loss harvesting for accounts at $50,000 which will save you more than their 0.25% APR cost. Wealthfront also has tax-loss harvesting but is not available until your account reaches $100,000.

Under $5,000 (Retirement Account or Tax-efficient Education Savings Account)-

Invest with Betterment. The cost will be 0.35% APR if you have an auto deposit set-up for at least $100 a month; otherwise, it will cost a flat $3 per month. Wealthfront has a minimum funding requirement of $5,000.

$5,000 - $100,000 (Retirement Account or Tax-efficient Education Savings Account)-

Invest with Wealthfront. They charge 0.00% APR on the first $10,000 invested. Betterment charges 0.35% APR on the first $10,000 invested. Both charge 0.25% after $10,000. This means you will pay $35 less per year on accounts between $10,000-$100,000 if you invest with Wealthfront instead of Betterment.

$100,000+ (Retirement Account or Tax-efficient Education Savings Account)-

Invest with Betterment. They charge 0.15% APR on accounts above $100,000. Wealthfront charges 0.25% APR.

If you are new to investing or would like to better understand portfolios, diversification, ETFs, risk, and receive guidance in selecting and opening a passive ETF investment account, I have an online course discounted 75% to $12.

T: Just thought I would share that after trying both services, I'm closing my Weathfront account and putting the money in Betterment. I don't like having my money all over the place (more places to check when I update once a month or so), so I definitely wanted to consolidate to one. Betterment is simply better designed for small investors. They make everything about the process easy, and their minimums are much lower. I also like that they have clearly designed their whole business model around the robo-investing, instead of having a traditional account/clearing house sitting behind the scenes, which introduces some limitations (no fractional shares).

The reason I tried Wealthfront in the first place is that the reporting on Betterment leaves much to be desired. I can't download to quicken and easily track cost basis and dividends. I like knowing what's coming tax-wise, and I can't do that easily. Other than that, I love Betterment and I'm sticking to it.

Bobby: On the other hand (re: reporting), Betterment makes it easy to download transactions into spreadsheet format -- which Wealthfront does not. Wealthfront also allows download to Quicken ONLY for taxable investments, not for IRAs. I use the CSV download from Betterment to compute Internal Rate of Return, build my own charts, etc. I use Mathematica, but spreadsheets can also do that.

Paul: Thanks for the great post and discussion! Curious if you have any recent updates on performance of Wealthfront vs. Betterment? I've been using WF for past 9 months and am now trying to assess performance. I like to be super aggressive and am disappointed that though I chose 9.5 risk level with Wealthfront it seems to have grossly underperformed the overall market as a whole. I'm curious about whether Betterment may have performed better particularly in the market climate of this past year. Of course we gotta take all such comparisons with a grain of salt given the short term period. :) (Also, I may have missed it if you mentioned but what risk level are you using with Wealthfront?) Thx!

Brian:
I think you both vastly mis-estimated what you were buying when you signed up to Wealthfront & Betterment. I use neither, not because I don't like online services, but because the strategies they are pursuing are flawed for the current market environment. Specifically, super-diversification is a make believe construct that works relatively well in inflationary environments - but will continue to perform poorly in dis-inflationary/deflationary environments.

In inflationary (aka - expansionary) environments money is being created through growth in profits and cash flows. That money can freely flow into more eccentric areas of the world. That is exactly opposite to what we are experiencing today. Money is flowing OUT OF emerging markets, commodities, small caps, etc. and into the U.S. markets.

It doesn't matter what risk level you choose on either of these services - all risk profiles are going to be biased to a strategy that isn't working in this environment and hence under-performing standard U.S. based benchmarks.

DROdio: Brian I get what you're saying due to the short term current market dynamics, but I'm in it for the long haul, and I want to do this passively-- not by trading actively-- so I don't want to change strategies when the market changes its movements.

Both Betterment and WealthFront claim to outperform the average investment advisor's portfolio, with claims like "Betterment would have outperformed the average investor with an investment advisor in 88% of all periods over the last decade" and "The Betterment portfolio has historically outperformed a DIY benchmark portfolio by as much as 1.8%."

So while I don't disagree with your statement per-se (and in fact I don't claim to be knowledgeable enough to even argue it), when I look at the data, it seems to me that this approach performs well -- and even outperforms -- over a 20+ year horizon. Do you disagree with that more macro point?

Brian: I understand that both services claim they WOULD HAVE outperformed, and I believe them. That's kind of the selling point of their offerings and what backtesting strategies is all about. However, the issue for me really comes down to whether the investment climate is the same today as it was over the past 10 years and will it return to what it was then over the next 20 years.

An off-topic example is that seasons. I could make the case that wearing shorts and a tee shirt worked well over the last six months and hence should work well over the coming 5 years. On average I might be right, but I also might be extremely uncomfortable over the coming 6 months as that strategy (wearing shorts & a tee shirt) leaves me cold. Sure, come spring-time it might make sense, but I have a while to wait until that time.

Back to investment strategies - I harbor no ill will against any strategy, and one can make the argument coherently in either direction as to whether these "semi-passive" approaches are well positioned. My suspicions are that we're in a long-term secular dis-inflationary/deflationary environment and that favors exactly the opposite strategies that worked well over the past 20 years. For how long? I don't really know.

Remember Japan has been in a bear market for well over 20 years at this point. So my main point is that these investment "seasons" can last a long, long time. My answer to your final question would be that the approaches favored by both Betterment and Wealthfront worked well over the past decade and MIGHT work well over the next 20 years, but it's by no means assured.

I think it's somewhat like counting cards at a blackjack table...the count might be in your favor and might suggest you play a hand in a certain way, but there is a lot of noise around the statistics. I would suggest that the count is signalling that these strategies aren't well-aligned with the current environment and, if anything, the economic environment is moving away from them further at present.

Regardless I do wish everyone well in their investments and only wish there was a simple to follow approach to long-term wealth. My secondary concern is that there is a LOT of money flowing into these types of passive strategies - and that typically happens at the apex, not the bottom.

Either way, I do wish you all success and look forward to following both Wealthfront's and Betterment's progress.

DROdio: Here's a performance update:

To re-iterate, I've allocated $5k to Betterment and $5k to Wealthfront as a long-term test. I'll be posting performance updates over time, but their absolute performance isn't as meaningful as their relative performance, since absolute performance is just a measure of how the market is doing generally. What I'm really interested in knowing is, over time, is one better served by placing a bet on Wealthfront, or Betterment?

Right now, both are in positive territory, with Betterment clocking a 0.5% gain and Wealthfront a 0.4% gain. They've both been tracking each other quite closely, even though their asset allocation mixes are pretty different (details on that below).

Here are screenshots from both apps -- as I've outlined below, although the Betterment user experience is generally much more usable than Wealthfront's, on mobile specifically I would give Wealthfront an edge, as you can see by the level of detail in these two screenshots.

Wealthfront's mobile view: Total portfolio value $5,022.43

Betterment's mobile view: Total portfolio value: $5,032.48 (NOTE: I realized that I invested $10 more into Betterment than I did into Wealthfront)