This is Why I Hate Low-Cost ETFs
ETF’s or Exchange-traded funds have been all the rage lately. Low-cost ETFs combined with a Robo-Advisor Platform can be a potent combination, right? That can be, but that may not be for everyone…
ETFs and Robo-advisors are a great innovation and there is no doubt about that. It’s great to see all of the innovations currently happening in the personal finance industry (which has been very slow to evolve).
To the average consumer, it can be a great investment, especially when compared to going at it yourself because most people are pretty terrible investors. That being said, many people view low-cost ETFs and Robo-Advisors as the end all be all investment. An investment that you can invest and then sit back and relax as you wait to earn passive income while forgetting everything else.
…and from there get rich and live happily ever after! Sounds wonderful – doesn’t it?!
Well, that’s is possible but over a LONG TIME. And it’s only ONE PIECE of the puzzle. You can’t look at investments in a vacuum. There are areas of your finances that are overlooked that can give you the same value if not more if you consider them and give them some attention.
What are Some Other Considerations?
1) Risk tolerance
Robo Advisors have some risk tolerance management, but very little with often no accountability. For example, you can change your risk tolerance at any point, and invest more aggressively. Many people are inclined to do this because we’re in the longest bull market in history. That may not be the best play though. Many conservative investors get greedy and will take on more risk than they can handle. This can blow back in their faces!
You want to align the risk in your portfolio with the risk you can psychologically handle as well as the risk you can sustain to reach your goals.
Many people will invest, but without thinking through the implication of the account type they’re investing in.
For example, people may not know the differences or benefits of investing in accounts such as 401(k), IRA, Roth, or a regular taxable investment account. And the truth is you can boost your returns by doing something as simple as using a tax-deferred or tax-free investment account.
Let’s do the math…
If you can be able to contribute up to $19, 000 to your 401(K) plan, which you are allowed to do anyway every year. You can contribute anywhere from Zero dollars to the maximum limit of 401(k) contributions which is $19,000 per year.
…and that is just from your end, by the way, there is also a potential employer’s contribution as well.
So let’s say you contribute the max to your 401(k) – What happens? If you do that, you will lower your taxable income by that $19, 000 contribution. For example, let’s say you earn a hundred $100,000 per year, just for round numbers, on the tax form you are earning $81, 000. So whatever the tax rate is, it will be on the $81, 000. How much money will that save you? For sake of the example will say you’re single. Well, $100,000 is at the 24% Marginal Tax Bracket nd at $81,000 you’re at the 22% marginal.
That’s $4,502 dollars of taxes you save! That money can be reinvested as well earning you even more return. If you use a regular investment account Robo-Advisor instead of a 401(K), it could be costing you money each year because you don’t get a tax deduction for a tax for a brokerage account. Oh, and did I mention that you also get tax-deferred growth on those accounts too…
If you use a brokerage account, you’re taxed on income and gains in the portfolio. That could turn your 8% return to something like 5 or 6% because taxes eat away your returns each year which can cost you hundreds of thousands of dollars over the course of a career. That opportunity cost can make you lose more than you would have otherwise saved by cutting costs.
As you can see, taking some simple financial planning steps can boost your net worth more easily than just chasing low-cost performance. If you invest in ETFs or A Robo-Advisor, make sure you are considering all implications to your personal finance, not just investment returns or investment costs.
What’s the Problem with ETFs and Robo-advisors?
Moral of the story – ETFs and Robo-advisors don’t have a problem in themselves. It’s more a user problem.
The problem is actually the people who see them as one size that fits all way to cut costs which is not the case. Because of this, people lose sight of some basic financial steps they can take and end up missing opportunities for the sake of “low costs”.
You can take advantage of investing in ETFs or Robo-Advisor alongside your goals.
So even if you have invested in Robo-advisor, make sure that you are taking some basic financial planning steps. The big picture of your finances covers everything from taxes, insurance, estate planning and any other thing that touches your finances. You wouldn’t go to the doctor just to check your heart only. Therefore, don’t just look at investments. Look at everything equally and represent everything equally. By doing that you can boost your overall wealth.