Why Effective Altruists Should Use a Robo-Advisor

By MichaelDickens @ 2015-08-04T03:37 (+10)

TL;DR: Go sign up for Wealthfront right now and transfer all your savings into it. If you’re young and/or you plan on donating most of your savings, choose the highest risk tolerance Wealthfront allows.

Investing Basics

You probably want to save money for retirement, or some future large purchase like a house. Many effective altruists have money that they want to donate eventually, but want to hold onto it for now. What should you do with that money while you’re keeping it?

The simplest option would be to keep all your money in a savings account at your bank. This way you’re guaranteed not to lose your money, but savings accounts earn hardly any interest. If you’re willing to put your money into some riskier investments, you will probably end up with a lot more money than when you started.

The two most important investment vehicles are stocks and bonds. You can buy these on your own, but you don’t need to.

Robo-Advisors

There are services like Wealthfront, called robo-advisors, that manage your money for you automatically. You give the robo-advisor some basic facts about yourself such as your age and how much risk you can tolerate, and it figures out a good way to allocate your money. You deposit your savings and the robo-advisor does the rest–you never have to worry about your savings again. A good robo-advisor invests your money to get the best possible returns for your risk tolerance.

Both individual and professional investors rarely outperform the market in the long run, so a robo-advisor like Wealthfront will probably manage your money better than either you or a professional would. Even better, Wealthfront has low fees–far lower than anything you’d get from a human money manager–so you get to keep more of your money.

When you sign up for Wealthfront, it will give you a short quiz to determine how much risk it thinks you’re willing to take on. The more risk you accept, the higher expected return you can get. Whatever this quiz tells you, it might be smart for you to choose the most aggressive, highest-risk allocation. As Carl Shulman explains in “Salary or startup? How do-gooders can gain more from risky careers”, effective altruists can afford to take on more risk than most people. To borrow his example, your tenth Ferrari isn’t as valuable as your first, but with your tenth vaccine, you can vaccinate a tenth kid and do just as much good as with your first vaccine. Most investors are highly risk-averse: not losing money is much more important to them than gaining money. But as effective altruists, we can afford to take risky bets because if we win big, we can do massively more good in the world.

For the curious, Colby Davis’s A Guide to Rational Investing explains in more detail why investing on your own or with a (human) advisor is a usually bad idea, and why it’s possible to do better than simply buying a total-market index fund. Wealthfront is likely to outperform a total-market index fund because it puts some of your money into emerging markets, which probably outperform the U.S. market in the long run.

Why not Betterment?

Betterment is another popular robo-advisor that offers a similar service to Wealthfront. I slightly prefer Wealthfront, but if you already use Betterment and you don’t want to switch, that’s probably fine. It would be counterproductive to get into a debate about the minor points in favor of one or the other–if you prefer to use Betterment, by all means do so. The main benefits to be had here come from putting your money into a good robo-advisor. After that, it doesn’t matter much which one you pick.

There are a few other robo-advisors on the market which might be just as good. I haven’t spent much time looking into any others, but I feel comfortable recommending either Betterment or Wealthfront.

Why not manage my own basket of index funds?

(If you don’t want to do this, you don’t need to read this section.)

Actually, if you choose a good asset allocation and stick with it, you can probably get better results managing your own assets than using a robo-advisor. This approach requires more dedication, and you need to have a strong stomach to stick with your strategy even when it performs badly. But if that sounds like you, you might want to pursue this approach instead.

For nearly risk-neutral investors, even Wealthfront’s highest-risk, highest-return allocation still leaves a lot of room to squeeze out more returns. You could earn considerably more money by putting a larger percentage of your portfolio into high-return assets, and the best way to do this is to manually manage your investments.

This means buying a basket of index funds with a high weighting in asset classes that have historically outperformed the broad market, which could include small-capitalization stocks, value stocks, and emerging market stocks. You should NOT simply buy a total U.S. or total world index fund. This will both perform worse than Wealthfront (because it is not weighted toward high-return asset classes) and have higher risk (because it is less diversified). It might sound like a total world index fund is maximally diversified, and in one sense it is because it holds stocks from every part of the world. But Wealthfront’s asset allocation has better diversification properties because it holds a higher weighting in asset classes that tend to be less correlated with each other.

I plan on writing a future post with some recommendations for nearly risk-neutral investors who want to manage their own investments. For anyone who wants to learn more now, I recommend William Bernstein’s The Intelligent Asset Allocator, which lays out which asset classes perform best and how to find a good allocation.

Is this just for effective altruists?

No, not really. Most people would be better off if they used a robo-advisor. But it’s particularly important that effective altruists are able to make money on their investments, because it means they will have more money to donate.

Disclaimers: I am not affiliated with Wealthfront; I just think robo-advisors are awesome. I am not a financial advisor and you should use your own judgment when making significant financial decisions.