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Is your Robo vs Index comparison fair?

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While I partially agree with your robo vs index opinion, I feel as though you failed to mention the only two things that make robo a value proposition vs index funds. Tax loss harvesting and automated deposits/allocation.

Tax loss harvesting is by far the biggest value proposition robo has and papers I have read on the topic value it at anywhere from 10-100 bps (most times well exceeding the 25 bps charged). Taking your simple approach without factoring this in will obviously show that index funds perform better, because the actual holdings in robos are indexes and then charge a fee of 25 bps.

The other value proposition is automated deposits and allocations. If I were a robo investor I may find it worth it to lag a Vanguard index portfolio by 25 bps if it means having made regular deposits of several thousand dollars rather than having it sitting in my checking account for me to get around to it when I have the time (hint: you will never have the time).

I’d like to see your thoughts on how to value each of these value propositions and interested to hear your thoughts.

Thank you

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Posted by Ryan McCormack (Questions: 1, Responses: 1)
Posted on 08/17/2017 1:47 PM
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Hi Ryan,

I think the impact of TLH is dramatically overstated by the Robo firms. Michael Kitces did a very nice analysis of this several years back and found that the real benefit is likely to be closer to 0.1% assuming any benefit at all.

https://www.kitces.com/blog/evaluating-the-tax-deferral-and-tax-bracket-arbitrage-benefits-of-tax-loss-harvesting/

You have to remember two keys things when discussing TLH:

1) It is just tax deferral and not tax savings.

2) You need losses to even benefit from it. So, for instance, in a year like 2017 where the global stock market is up 10% in the first 8 months there is zero benefit from TLH because you need the market to go negative to even create a loss in the first place. So, TLH works best when you invest and immediately get crushed to take a big loss that you can carry forward. If you invest and the market goes up without ever creating the potential to harvest a loss then you will literally never experience a benefit from TLH. This latter example is the far more common real experience that an investor will go through.

A lot of this is just slick marketing from the Robo firms. They act like there’s a free lunch out there that technology can tap into, but the reality is that they underperform in large part because they’re creating frictions in their extra activity that results in some index deviation.

As for automated deposits – yeah, I like that feature. There’s no denying that the automation of these services helps to streamline the investing process. Is it worth 40-100 bps? Maybe for some people, but if you’re diligent about your money then I’d prefer to save on the fees and keep it simpler.

And please don’t take my criticism the wrong way. I much prefer Robos over most traditional fund managers and advisors charging 1%+.

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Cullen Roche Posted by Cullen Roche (Questions: 10, Responses: 1749)
Answered on 08/18/2017 11:16 AM
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