You've decided that you want a good asset allocation that balances risk tolerance and risk capacity. You want an optimal implementation, perhaps one with multi-factor tilts. And you want ongoing opportunistic rebalancing, tax-loss harvesting, and tax-efficient asset location. Who wouldn't? It's money in your pocket, compounding over time, that you're otherwise lighting on fire.
So...how? Do you do it yourself? Do you hire someone else? What are your options? Turns out that there are several, so let's go into each of them in turn.
Doing it yourself
DIY is always an option with investing. You can come up with your own asset allocation. You can pick the funds to implement it. You can figure out which accounts to put what asset classes in so as to maximize efficiency and minimize taxes. You can check your holdings on a frequent basis for tax-loss harvesting and opportunistic rebalancing.
If it sounds like a lot of work, it is, especially if you don't have good systems to help you out. However, as your investments grow to hundreds of thousands of dollars or more, even a small increase in returns -- compounding over decades! -- can add up to a lot of money. And if you DIY, it all ends up in your pocket; you don't have to share it with an investment manager or robo-advisor!
One thing to be aware of, however, is that DFA -- the grandfather of multi-factor tilts -- is not available to DIY investors. Take a look at this article for reasons why you may not want to miss out on that.
I've spent a lot of time talking about financial advisors: what the word even means, how to find one, how to interview one, and so on. If they do both financial planning and investment management, that can often be ideal. As a financial planner, the advisor can help you hone in on the perfect asset allocation, taking the time to get your risk tolerance and risk capacity right. Once that's dialed in, they can then implement your allocation and manage your investments in a way that meshes perfectly with the rest of your financial plan.
The one thing to be careful of is that not all financial advisors implement the aforementioned features. They might offer multi-factor tilts through DFA but not daily opportunistic rebalancing, or tax-loss harvesting without tax-efficient asset location. I highly recommend you find one that offers all of them, and generally speaking, you shouldn't have to pay a large premium to get them.
If you act as your own financial planner, or perhaps you have a financial planner that you really like but doesn't manage investments (or doesn't manage them the way you want), you can hire an investment manager who's separate from your financial planner. Generally speaking, the same caveats apply here as for financial advisors: make sure they have the features that you want. Additionally, you'll need to make absolutely sure that the asset allocation you and your planner came up with is implemented properly by the investment manager.
And be aware that most investment managers offer financial planning as well, and rarely do they charge less if you don't take advantage of that service; if your investment manager charges 1% of your assets under management or more just for managing your investments, you're likely overpaying!
Relative newcomers to the scene, "robo-advisors" like Betterment and Wealthfront have taken the investing world by storm. While a typical financial advisor offers planning and investment management for 1% of assets under management, "robo-advisors" tend to charge something closer to 0.25%. Per my comments on DIY above, 0.75% can really add up over time! And the great news is that opportunistic rebalancing, tax-loss harvesting, and tax-efficient asset location are generally considered to be table stakes, offered by any serious contender in the space.
There are a few downsides here, though. For one, DFA doesn't work with "robos" any more than it works with DIY investors, as DFA doesn't carry the ETF's that are robo-advisors' bread-and-butter. Also, robo-advisors have a limited view of your financial picture, and in particular aren't (yet!) capable of allocating assets that they don't control -- for example, a 401(k). And of course there's only so much software can do on the financial planning side -- in particular, be wary of determining your asset allocation via a slider on an app!
Perhaps most importantly, though, robo-advisors were started by venture capitalists, and they've been around for long enough that their investors are ready for them to make a serious return on investments -- which means they've been changing how they operate. For example, Betterment recently raised their fees and added call-center-type human advisors, and Wealthfront recently switched part of many investors' portfolios to an expensive risk-parity fund that it owned itself. In both cases, there was an uproar, and in both cases the company moved to address it, but it still leaves me (slightly!) less optimistic about them than I used to be. And I'm not alone.
A choice algorithm for investment management
So let's assume you want tax-loss harvesting, opportunistic rebalancing, and tax-efficient asset location. How do you choose? Here's an algorithm that may help:
ASSERT (for non-programmers: "make sure this is true"): you have a solid asset allocation that matches your risk tolerance and risk capacity. Whether you worked with a financial planner to develop it or came up with it yourself, this is the precondition for doing any other investment management work. This is the Big Lever, the Minimum Viable Product; all the stuff below is optimization (albeit very profitable optimization!) on top of it.
Asset allocation in place? Good. Now:
IF you want DFA-implemented multi-factor tilts: As this isn't available for robo-advisors or DIY investors, I recommend finding a financial advisor who does financial planning and investment management. IF you already have a financial planner whom you love and doesn't charge for investment management, I recommend finding an investment manager who doesn't charge for financial planning to complement them. Of course, make sure they offer all the features we've been talking about!
ELSE (everything below this assumes you don't want DFA):
IF you have the time, expertise, and desire to do DIY: go ahead and do it yourself! You've got a solid asset allocation in place, so go ahead and do opportunistic rebalancing, tax-loss harvesting, and tax-efficient asset allocation to your heart's content. If you find that you don't consistently have the time or energy, though, I recommend handing it off to someone/something else; there's just too much (compounding!) returns you're leaving on the table otherwise!
ELSE: consider a robo-advisor like the ones mentioned above. The benefit of opportunistic rebalancing alone will likely more than compensate for their fees, not to mention the tax-related optimizations.
It's a general algorithm that doesn't take into account all the little exceptions, of course, but it's a good framework to start from. (Full disclosure: Seaborn isn't paid by DFA or robo-advisors, though we do use DFA funds, among others. See this article for why we like them.)
For those of you who've already gone through your own choice algorithm: what did you end up deciding, and why? Post a comment or drop me a line!
Britton is an engineer-turned-financial-planner in Austin, Texas. As such, he shies away from suits and commissions, and instead tends towards blue jeans, data-driven analysis, and a fee-only approach to financial planning.