You’ve probably already heard some buzz about robo-advisors or online brokerages. After all, both investing platforms have earned praise for being the more affordable and transparent alternative to financial advisors; but which option is better for your investing needs?
This article focuses on the benefits of using each respective investing platform and provides all of the details concerning each passive and active investing platform.
Things to consider before investing with a robo-advisor or an online brokerage
Deciding to invest through a robo-advisor or an online brokerage should come as a relatively easy decision. This, however, depends on a few factors.
Knowing whether you want to be a passive investor or an active investor depends entirely on how involved you’d like to be when it comes to managing your investments.
Passive investing is investing that does not require constant monitoring of investments or frequent decision making. Using a robo-advisor or purchasing Mutual Funds, Index Funds, or Exchange-Traded Funds (ETFs) are all passive investing options.
There isn’t as much research involved, either. And with the recent launch of all-in-one ETFs,—indexed ETFs that invest in a mixture of stocks and bonds that automatically rebalance themselves—there’s even less research you need to do.
Active investing, on the other hand, requires the investor to make their own trading decisions. It involves much more monitoring and involvement, as well as research about the companies and fund management.If you’re an active investor, you’ll choose individual stocks or bonds and buy and sell them whenever you decide best. You should research your investments before making any decisions on whether to buy or sell.
Risk Toleranceis an investor’s ability to tolerate risk. However, it can be more realistically defined as an investor’s ability to stomach loss. Risk tolerance allows the investor to understand the risk and volatility of their investments. When it comes to robo-advisors, investors are asked a few questions and built an ETF or Index Fund according to their risk profile.
There are a few types of accountsthat you can hold your investments can hold, which are divided into categories: registered and non-registered.A registered account—such as an RRSP, TFSA, or RESP—is registered with the Canadian government and allows your money to grow tax-free. You only pay tax when you make a withdrawal from your RRSP, but not a TFSA. With an RESP, only the government grants and investment income earned are taxed, not the contributions.
Since your child is likely making the withdrawals as a student and probably has little to no income, it’s unlikely he or she will pay very much tax.Registered accounts—such as a Registered Retirement Savings Plan (RRSP) or Tax-Free Savings Account (TFSA)—are less complicated because you won’t have to worry about calculating taxable income.
Non-registered accounts are not tax-free accounts. Any dividends, gains, or interest earned is taxed according to the investor’s income tax bracket.
When you invest, it’s best to put your money into a TFSA or RRSP to minimize the amount of tax you pay. It also makes filing your taxes a lot easier—if you haven’t reached your TFSA contribution limitor your RRSP contribution limit.
The difference between robo-advisors and online brokerages
Knowing the difference between a robo-advisor and an online brokerage is a crucial step—perhaps half the battle—in the decision-making process.
In brief, robo-advisors are most suitable for people who want to invest but do not have the expertise or patience to manage their investments. Robo-advisors manage and choose investments on behalf of the investor.
On the other hand, online brokerages are incredibly suitable for investors who are comfortable managing their trades. They’re also ideal for those who are technologically savvy and prefer to make the trades themselves instead of paying a broker to purchase stocks for them or manage their funds.
Investing with a robo-advisor
A robo-advisor collects information from you about your risk tolerance levels, your goals, and your income. Once it has that information, it invests in a variety of ETFs. It also rebalances your portfolio regularly.Robo-advisors use a passive investment strategy. The ETFs are purchased buy track an index, such as the S&P/TSX Composite Index or the S&P 500. The goal of the ETF is to match the index’s return, not beat it.
There are many benefits of robo-advisors:
- You don’t have to buy an overpriced mutual fund. Instead, the robo-advisor buys a basket of low-cost ETFs.
- Portfolio rebalancing is automatic.
- Contributions can be made regularly, at no additional cost.
With a robo-advisor, you pay the annual cost of the ETFs—which is usually around 0.2%–plus an annual management fee of about 0.5%. In total, the average price is often approximately 0.7%. Many studies have shown that mutual fund costs eat into an investor’s overall return, especially those that are charging 2% annually.
