Copernican Journal of Finance & Accounting e-ISSN 2300-3065 p-ISSN 2300-12402017, volume 6, issue 3 Date of submission: June 4, 2017; date of acceptance: September 10, 2017. * Contact information: k.nowak@doktorant.umk.pl, Nicolaus Copernicus Universi- ty in Torun, Gagarina 13a, 87-100 Torun, Poland, phone: +48 607 552 226; ORCID ID: https://orcid.org/0000-0002-8567-122X. Nowak, K. (2017). Low cost retirement solutions based on robo-advisors and Exchange Traded Funds. Copernican Journal of Finance & Accounting, 6(3), 75–94. http://dx.doi.org/10.12775/ CJFA.2017.018 kaMIl nowak* Nicolaus Copernicus University in Torun low cost retIreMent solutIons based on robo-advIsors and exchange traded funds Keywords: robo advisors, ETF, retirement. J E L Classification: G11. Abstract: This paper brief ly analyzes American retirement system and bares its short- comings. The post crisis economic reality, low savings rates and misguided policy chan- ges, requires searches for new retirement solutions. Especially it’s worth to have a se- cond look at costs of traditional retirement products. Analysis of mutual funds expense ratios and financial advisors fees proofs their significant impact on future retirement. New products based on ETFs and managed by robo advisors are the low cost alterna- tive. The substance of this paper is cost comparison of traditional retirement products with innovative FinTech solutions. In a result of this analysis robo advisors and ETFs turned out to be definitely more cost effective, what makes investing more accessible and substantially increases future retirement.  Introduction It would seem that nowadays we have a knowledge and technology to provide stable and long retirement income. Utilizing years of researches combined with innovative financial instruments it should be simple to design effective retire- Kamil Nowak76 ment system. Despite those assumptions looking at many countries retirement systems, it’s still challenging. Analyzing American retirement system is not hard to come to a conclusion, that crisis is the best word describing it. Of course, most of the root causes of the problem lies in human nature. Low saving rates makes people more tend to spend their earnings now than save for the future. Aver- age employees lack in financial knowledge, so shift from employer driven plans to employee’s responsibility might be confusing. They don’t know how much to save and how to invest. What is more, progress of medicine allows people to live longer. Longevity of life not connected with longer working period contributes to crisis as well. On the other hand, majority of crisis causes lie in macroeconom- ic circumstances and policy errors. Poor market returns in conjunction with high management fees obviously don’t encourage to investing. What is more, US tax regulations favors Direct Benefit plans which allows large percentage of in- come to be deferred. When Direct Contribution plans has tax deferral limits sets so low, that retiring on tax deferred balances is not an option (Brinson & Siegel, 2015, p. 6). Shift from DB to DC plans besides transferring investment risk from employer to employee, brought higher fees as well, because DC plans, unlike DB, invest in mutual funds, where fees are higher. Which type of plan is the most common nowadays? Figure 1 shows that it will be IRAs, despite of the fact that those plans are not sponsored by employer. Most of the IRAs assets have been rolled out from employer sponsored plans. In 2016 IRAs contribution hit 31% of all the retirement assets. Based on that fact it can be said, that the return from IRAs have a substantial impact on their holders retirement. Figure 1. US retirement assets 2Q 2016 saving rates makes people more tend to spend their earnings now than save for the future. Average employees lack in financial knowledge, so shift from employer driven plans to employee’s responsibility might be confusing. They don’t know how much to save and how to invest. What is more, progress of medicine allows people to live longer. Longevity of life not connected with longer working period contributes to crisis as well. On the other hand, majority of crisis causes lie in macroeconomic circumstances and policy errors. Poor market returns in conjunction with high management fees obviously don’t encourage to investing. What is more, US tax regulations favors Direct Benefit plans which allows large percentage of income to be deferred. When Direct Contribution plans has tax deferral limits sets so low, that retiring on tax deferred balances is not an option (Brinson & Siegel, 2015). Shift from DB to DC plans besides transferring investment risk from employer to employee, brought higher fees as well, because DC plans, unlike DB, invest in mutual funds, where fees are higher. Which type of plan is the most common nowadays? Figure 1 shows that it will be IRAs, despite of the fact that those plans are not sponsored by employer. Most of the IRAs assets have been rolled out from employer sponsored plans. In 2016 IRAs contribution hit 31% of all the retirement assets. Based on that fact it can be said, that the return from IRAs have a substantial impact on their holders retirement. Figure 1. US retirement assets 2Q 2016 Source: author’s own elaboration based on: http://us.pensiontracker.org/index.php. Considering that IRAs holds a bulk of Americans retirement savings it is worth to compare return rates between types of plans. Figure 2 shows geometric return rates from DB, DC and IRA plans calculated over 12 years (2000-2012). During that time so popular IRAs produced substantially lower returns that DB or DC. There are two reasons of lower returns: higher fees and assets allocation. Comparing to 4% of the assets invested in money $5,2 $2,8 $7,5 $7,0 $2,0 US retirement assets 2Q 2016 State DB Private DB IRA DC Annuities S o u r c e : author’s own elaboration based on: http://us.pensiontracker.org/index.php. low Cost rEtirEmEnt solutions BasEd on roBo-advisors… 77 Considering that IRAs holds a bulk of Americans retirement savings it is worth to compare return rates between types of plans. Figure 2 shows geo- metric return rates from DB, DC and IRA plans calculated over 12 years (2000– –2012). During that time so popular IRAs produced substantially lower returns that DB or DC. There are two reasons of lower returns: higher fees and assets allocation. Comparing to 4% of the assets invested in money funds by DC aver- age IRAs invest up to 11% in those in fact safe but low return funds (Munnell et al., 2015, p. 6). Figure 2. Geometric rates of return by plan type (2000–2012) funds by DC average IRAs invest up to 11% in those in fact safe but low return funds (Munnell et al., 2015). Figure 2. Geometric rates of return by plan type Source: Aubry, Crawford, Munnell, Investment returns: Defined Benefit vs. Defined Contribution Plans, Center for Retirement Research Boston College, 2015. For many years bonds were a key components of retirement portfolios. Considering goal of bringing income that allows 4-5% annual withdrawals during retirement, the bond yields were a great and safe choice until 2000, when interest rates started falling. Today 10 years US T-bond yield doesn’t exceed 2%. What is more dividend yields have fallen to as low as slightly more than 2% for S&P 500 Index. Considering above mentioned conditions, conservative retirement portfolio based on bonds and dividend stocks is a good and safe solution to preserve the value of capital, but at once is very risky in terms of income point of view. If the goal of 4-5% annual withdrawals of income during retirement has to be reached, we should look for other solutions than bond and dividend stocks. Except allocation of assets, fees are other important factor that contributes to future retirement income. To understand how significant is an impact of fees on an individual retirement it’s worth to quote the example brought by Ericskon and Madland (Ericson & Madland, 2014), which demonstrates how small difference in fees results in significant difference in future retirement. Figure 3 demonstrates how big can be a difference between funds with an expense ratio 0.25%, 1% and 1.3% in fees paid over a lifetime by 25 years old employee earning 30,502 USD (which is a 2014 median salary in the US for that age group) and an employee earning 75 000 USD. Both individuals contribute 5% of their salary which is 2,2% 3,1% 4,7% 0,0% 0,5% 1,0% 1,5% 2,0% 2,5% 3,0% 3,5% 4,0% 4,5% 5,0% IRA DC DB Geometric rates of return by plan type (2000–2012) S o u r c e : Aubry, Crawford, Munnell, Investment returns: Defined Benefit vs. Defined Contribu- tion Plans, Center for Retirement Research Boston College, 2015, p. 6. For many years bonds were a key components of retirement portfolios. Con- sidering goal of bringing income that allows 4–5% annual withdrawals during retirement, the bond yields were a great and safe choice until 2000, when in- terest rates started falling. Today 10 years US T-bond yield doesn’t exceed 2%. What is more dividend yields have fallen to as low as slightly more than 2% for S&P 500 Index. Considering above mentioned conditions, conservative retire- ment portfolio based on bonds and dividend stocks is a good and safe solution to preserve the value of capital, but at once is very risky in terms of income point of view. If the goal of 4–5% annual withdrawals of income during retirement has to be reached, we should look for other solutions than bond and dividend stocks. Except allocation of assets, fees are other important factor that contrib- utes to future retirement income. To understand how significant is an impact of fees on an individual retirement it’s worth to quote the example brought by Er- Kamil Nowak78 icskon and Madland (Ericson & Madland, 2014, p. 1), which demonstrates how small difference in fees results in significant difference in future retirement. Figure 3 demonstrates how big can be a difference between funds with an ex- pense ratio 0.25%, 1% and 1.3% in fees paid over a lifetime by 25 years old em- ployee earning 30,502 USD (which is a 2014 median salary in the US for that age group) and an employee earning 75 000 USD. Both individuals contribute 5% of their salary which is matched by an equal employer contribution, which re- sults in 10%. As it can be seen from the figure the difference can be as high as 124 000 USD for an employee with a median salary and as high as 300 000 USD for the employee earning 75 000 USD. If impact of the fees on future retirement is so substantial, it’s definitely worth to look for low cost retirement solutions. The main goal of this paper is to look for new low cost, performing well in a long run funds, that can be used as a core of retirement portfolios. Figure 3. Total fees paid over lifetime by average employees matched by an equal employer contribution, which results in 10%. As it can be seen from the figure the difference can be as high as 124 000 USD for an employee with a median salary and as high as 300 000 USD for the employee earning 75 000 USD. If impact of the fees on future retirement is so substantial, it’s definitely worth to look for low cost retirement solutions. The main goal of this paper is to look for new low cost, performing well in a long run funds, that can be used as a core of retirement portfolios. Figure 3. Total fees paid over lifetime by average employees Source: author’s own elaboration based on: Erickson, Madland, Fixing the drain on retirement savings, Center of American Progress, 2014. Literature review Exchange Traded Funds have rather a brief history. First significant studies can be dated on first decade of 21st century. ETF’s definition, description and advantages were demonstrated by Bernstein (Bernstein, 2001) and Gastineau (Gastineau, 2001), who described their main types and investigated how the operate. One of the first comparisons of ETFs and traditional mutual funds was provided by Dellva (Dellva, 2001). He presented cost benefits of ETFs. Tax advantages were studied by Poterba nad Shoven (Shoven, 2002), who compared pre and after tax returns of popular index funds. Kostovetsky broadly compared ETFs and mutual funds by confronting their returns, transaction costs and expenses and tax efficiency (Kostovetsky, 2003). Since literature offers wide range of positions touching ETF topic, selection of digital advisory studies is rather poor. Robo- advisory is a recent phenomenon, that is why not many researches can be found. Fein provided an analysis of robo-advisors fiduciary standars. Advantages of digital advisory were discussed by Dapp (Dapp, 2016). Impact of recent FinTech innovations on asset management and banking business was examined by Sironi (Sironi, 2016). Digital $42 309 $138 336 $166 420 $0 $50 000 $100 000 $150 000 $200 000 0,25% 1,00% 1,30% Salary when worker starts saving at age 25: $30,502 $104 033 $343 147 $409 202 $0 $100 000 $200 000 $300 000 $400 000 $500 000 0,25% 1,00% 1,30% Salary when worker starts saving at age 25: $75,000 matched by an equal employer contribution, which results in 10%. As it can be seen from the figure the difference can be as high as 124 000 USD for an employee with a median salary and as high as 300 000 USD for the employee earning 75 000 USD. If impact of the fees on future retirement is so substantial, it’s definitely worth to look for low cost retirement solutions. The main goal of this paper is to look for new low cost, performing well in a long run funds, that can be used as a core of retirement portfolios. Figure 3. Total fees paid over lifetime by average employees Source: author’s own elaboration based on: Erickson, Madland, Fixing the drain on retirement savings, Center of American Progress, 2014. Literature review Exchange Traded Funds have rather a brief history. First significant studies can be dated on first decade of 21st century. ETF’s definition, description and advantages were demonstrated by Bernstein (Bernstein, 2001) and Gastineau (Gastineau, 2001), who described their main types and investigated how the operate. One of the first comparisons of ETFs and traditional mutual funds was provided by Dellva (Dellva, 2001). He presented cost benefits of ETFs. Tax advantages were studied by Poterba nad Shoven (Shoven, 2002), who compared pre and after tax returns of popular index funds. Kostovetsky broadly compared ETFs and mutual funds by confronting their returns, transaction costs and expenses and tax efficiency (Kostovetsky, 2003). Since literature offers wide range of positions touching ETF topic, selection of digital advisory studies is rather poor. Robo- advisory is a recent phenomenon, that is why not many researches can be found. Fein provided an analysis of robo-advisors fiduciary standars. Advantages of digital advisory were discussed by Dapp (Dapp, 2016). Impact of recent FinTech innovations on asset management and banking business was examined by Sironi (Sironi, 2016). Digital $42 309 $138 336 $166 420 $0 $50 000 $100 000 $150 000 $200 000 0,25% 1,00% 1,30% Salary when worker starts saving at age 25: $30,502 $104 033 $343 147 $409 202 $0 $100 000 $200 000 $300 000 $400 000 $500 000 0,25% 1,00% 1,30% Salary when worker starts saving at age 25: $75,000 S o u r c e : author’s own elaboration based on: Erickson, Madland, Fixing the drain on retirement savings, Center of American Progress, 2014, p. 3. Literature review Exchange Traded Funds have rather a brief history. First significant studies can be dated on first decade of 21st century. ETF’s definition, description and ad- vantages were demonstrated by Bernstein (Bernstein & Phyllis, 2002, p. 39) and Gastineau (Gastineau, 2001), who described their main types and investi- gated how the operate. One of the first comparisons of ETFs and traditional mu- tual funds was provided by Dellva (Dellva, 2001). He presented cost benefits of ETFs. Tax advantages were studied by Poterba nad Shoven (Poterba & Shoven, low Cost rEtirEmEnt solutions BasEd on roBo-advisors… 79 2002), who compared pre and after tax returns of popular index funds. Ko- stovetsky broadly compared ETFs and mutual funds by confronting their re- turns, transaction costs and expenses and tax efficiency (Kostovetsky, 2003). Since literature offers wide range of positions touching ETF topic, selection of digital advisory studies is rather poor. Robo-advisory is a recent phenomenon, that is why not many researches can be found. Fein provided an analysis of ro- bo-advisors fiduciary standars. Advantages of digital advisory were discussed by Dapp (Dapp, 2016). Impact of recent FinTech innovations on asset manage- ment and banking business was examined by Sironi (Sironi, 2016). Digital ad- visory business overview can be found in numerous reports prepared by major consulting companies, like Infosys, which predicts 120% annual asset growth, Accenture sees a pressure put on traditional advisors to lower their fees a re- sult of robo-advisory growing popularity. While Finextra states that impact of robos on present wealth advisory will be disruptive, BlackRock recognizes a gap in existing financial regulations that needs to be filled to cover digital ad- visory. In view of novelty of this phenomenon, there is still a space for compre- hensive studies about robo-advisory. The research methodology and the course of the research process The paper contains empirical analysis and descriptive research studies carried out in several steps. First step looks into American retirement system and iden- tifies its shortcomings. Than taking a closer look at traditional products, their cost’s impact on future retirement is measured. Thereafter advantages of ETFs and robo advisors in terms of retirement are presented. Finally, paper com- pares mutual funds’ and ETFs return rates and expense ratios. Morningstar database has been used to find funds annual return rates and expense ratios. 10 years period has been analyzed. To determine mutual funds’ ETF alterna- tives author used ETFdb.com Mutual Fund to ETF Converter Tool (www.etfdb. com), which utilizes mutual funds benchmarks to find the most corresponding ETFs linked to the same benchmark. The study ends with conclusions achieved by literature review and summary of provided analysis. Kamil Nowak80 ETFs as low cost retirement solutions Since first ETFs were introduced in early nineties, their popularity grew rapid- ly. Nowadays ETFs became major part of asset management business and def- initely the fastest growing segment of that business. They dominated index- based investing. Looking at the massive, over 2000% growth during the last 10 years, this is just a matter of time until ETFs will overtake mutual fund in- dustry. When it seems like exchange traded funds business is thriving, there is still a segment of the market which is still out of the reach of ETFs – retirement fund business. According to ICI investors holds only 0.02% of their 401K in ex- change traded funds. Accurate data for IRA is not available, but according to ICI 48% of assets is held in mutual funds, the rest in other investment vehicles including ETFs. Considering further research in this paper proving many ETFs advantages over traditional investment funds, the question arises: what are the reasons of mutual funds dominancy in retirement segment of the market? The answer is very interesting and lies in one of ETFs core advantages – intra daily trading. Most defined contribution fund provider’s infrastructure isn’t ready for intraday trading. The update is of course possible, but requires substan- tial expenses, so for the most of the industry holding status quo isn’t only con- venient but very profitable as well. Market examples proves that adopting ETFs to defined contribution fund business doesn’t have to be expensive. Vanguard solved the problem of intraday trading by applying contributions into money market fund first and then allowing participants to convert the assets to cho- sen ETF when feasible. That is an example of frugal solution, but the most de- sired one is to develop new platform supporting intra daily trading, e.g. Charles Schwab, to allow investors fully benefit from one of many ETFs advantages. What are the other advantages? and Where does that growing popularity come from? The answer is very simple and ‘exchange traded’ is the key reason to unique features that differs ETFs from other investment vehicles: ■ Accessibility – Markets and asset classes reserved only for large institu- tional investors became easily accessible for individual investors. ■ Transparency –ETFs are obliged to display their portfolios on a daily ba- sis. ETFs investors unlike mutual funds clients do not have to wonder where their funds have been invested between reporting periods or if a portfolio manager has taken unnecessary risk. Knowing the underly- ing assets investors may avoid doubling the exposures by holding those assets elsewhere. low Cost rEtirEmEnt solutions BasEd on roBo-advisors… 81 ■ Liquidity – ‘Exchange traded’ is the key to ETFs extraordinary liquidity. They can be traded multiple times, daily exactly as stocks with transpa- rency and regulatory protection. Also like stocks ETFs can be held with a margin, shorted or optioned. The creation/redemption process allows investors to arbitrage between fund and its underlying securities. ■ Tax efficiency – Unlike mutual funds ETFs do not expose their sharehol- ders to capital gains distributions. The redemption in kind ability prac- tically eliminates the need of capital gains distributions. ■ Costs – Last but not least, probably the biggest, advantage of ETFs is the- ir expense ratio. Average mutual fund expense ratio is almost 150% hi- gher than average ETF’s expense ratio. The savings can be achieved be- cause ETFs are traded on the stock exchange and most of the costs like recordkeeping or sending the prospectus are borne by brokers. In summary ETFs set up new investing standards (Nowak, 2016, p. 166). With lower costs, liquidity, accessibility and tax efficiency this isn’t a surprise, that they are attracting investors money definitely faster than regular mutu- al funds (Hill et al., 2015, p. 9). All ETF’s unique features contributed to their growing popularity, but from the retirement point of view the most important is cost effectivity. According to Morningstar, the average expense ratio for an index U.S. ETF is 0.35% and 0.87% for actively managed ETF, although many of the most popular index tracking ETFs offer ratios below 0.1%. Comparing to mutual funds, which average fee is 0.65% for a passive fund and 1.21% for an active fund. Considering how even small differences in fees impact future re- tirement (see figure 3), that is definitely worth to take a closer look on fees and performance of ETFs and traditional mutual funds. Table 1 shows expense ratio and performance of 11 biggest mutual funds tracking S&P 500 Index. While Ta- ble 2. Presents the same data for 3 major ETFs, tracking S&P 500 as well. Look- ing at AUM, it’s obvious that traditional mutual funds still dominate the market. Average index tracking mutual fund manages 27.08 billion dollars of assets. While average AUM for ETFs is not even 60 million. Of course Exchange Traded Funds are still growing segment of assets management business. Where does this fast growth come from? Table 1. Mutual funds tracking S&P 500 expense ratio and performance Fund Ticker AUM (millions USD) Expense ratio (%) Performance (%) +/- S&P 500 (%) 1 Yr 3 Yr 5 Yr 10 Yr 1 Yr 3 Yr 5 Yr 10 Yr Vanguard 500 Index Investor VFINX 306400 0.14 21.29 10.14 13.77 7.53 -0.69 -0.12 -0.23 -0.12 Fidelity 500 Index Fund Investor Class FUSEX 116600 0.10 21.34 10.21 13.84 7.58 -0.64 -0.06 -0.16 -0.07 Schwab S&P 500 Index SWPPX 25800 0.09 21.34 10.18 13.83 7.61 -0.65 -0.09 -0.17 -0.04 BlackRock S&P 500 Index Fund Investor A WFSPX 10100 0.36 21.02 9.90 13.50 7.27 -0.08 -0.42 -0.40 -0.38 USAA S&P 500 Index Fund Member Shares USSPX 6200 0.25 21.14 10.01 13.64 7.40 -0.84 -0.25 -0.36 -0.25 Principal LargeCap S&P 500 Index Fund Class A PLSAX 5300 0.48 21.33 9.72 13.37 7.00 -0.58 -0.53 -0.61 -0.64 TIAA-CREF S&P 500 Index Retire TRSPX 4100 0.30 21.06 9.95 13.58 7.33 -0.93 -0.31 -0.42 -0.32 MM S&P 500® Index Fund Class A MMFFX 3800 0.72 20.56 9.51 13.15 6.93 -0.89 -0.79 -0.79 -0.72 Nationwide S&P 500 Index Fund Class A GRMAX 2600 0.60 20.71 9.66 13.28 7.05 -0.74 -0.63 -0.66 -0.60 State Farm S&P 500 Index Fund Class A SNPAX 1400 0.68 20.62 9.51 13.10 6.87 -0.83 -0.79 -0.84 -0.78 MainStay S&P 500 Index Fund Class A MSXAX 1300 0.60 20.75 9.66 13.27 7.06 -0.70 -0.63 -0.67 -0.59 Invesco S&P 500 Index Fund Class A SPIAX 1000 0.59 20.75 9.65 13.29 7.12 -0.70 -0.64 -0.65 -0.53 Deutsche S&P 500 Index Fund Class A SXPAX 940 0.64 21.23 9.55 13.25 6.99 -0.77 -0.71 -0.74 -0.66 low Cost rEtirEmEnt solutions BasEd on roBo-advisors… 83 Fund Ticker AUM (millions USD) Expense ratio (%) Performance (%) +/- S&P 500 (%) 1 Yr 3 Yr 5 Yr 10 Yr 1 Yr 3 Yr 5 Yr 10 Yr State Street Equity 500 Index A SSSVX 870 0.47 20.37 9.58 13.33 7.25 -1.08 -0.71 -0.61 -0.41 Rydex S&P 500 Fund Class A RYSOX 280 1.55 19.4 8.47 12.08 6.17 -0.7 -0.64 -0.65 -0.53 QS S&P 500 Index Fund Class A SBSPX 250 0.59 20.79 9.67 13.3 7.08 -0.65 -0.62 -0.63 -0.57 Victory S&P 500 Index Fund Class A MUXAX 250 0.58 20.91 9.68 13.23 7.02 -0.54 -0.62 -0.71 -0.64 PNC S&P 500 Index Fund Class A PIIAX 160 0.44 20.81 9.65 13.32 7.1 -0.63 -0.64 -0.62 -0.55 Average 27075 0.51 20.86 9.71 13.34 7.13 -0.70 -0.51 -0.55 -0.47 Median 2000 0.53 S o u r c e : author’s own elaboration based on: Data source: Morningstar 15.03.2017. There is as many answers as many unique features of ETFs, but one of them is expense ratio. Comparing average expense ratio of 0.51% for mutual funds and 0.06% for ETFs, the choice of conscious investor is simple. Especially con- sidering that index tracking ETFs perform slightly better than mutual funds. In one year period the investor can earn 0.40% more investing in ETFs. Compar- ing performance in terms of retirement – 10 year return rate differs by 0.45%. What is more, Exchange traded funds more accurately track their underlying index. During last 5 years average difference between ETFs performance and S&P 500 is only 0.01%. While mutual funds brought 0.55% less return than their underlying index. Relating those findings to retirement considerations it’s hard not to come to conclusion, that index tracking ETFs are better choice than traditional mutual funds because of their cost effectiveness, performance and accuracy. Table 1. Mutual funds tracking S&P 500 expense ratio and performance Kamil Nowak84 Table 2. ETFs tracking S&P 500 expense ratio and performance Fund Ticker AUM (millions USD) Expen- se ratio (%) Performance (%) +/- S&P 500 (%) 1 Yr 3 Yr 5 Yr 10 Yr 1 Yr 3 Yr 5 Yr 10 Yr S&P 500 Index 21.00 10.28 13.97 7.66 – – – – SPDR S&P 500 ETF SPY 210 0.09 21.35 10.17 13.84 7.56 0.35 -0.11 -0.13 -0.10 iShares Core S&P 500 ETF IVV 100 0.04 21.00 10.22 13.91 7.60 0.00 0.06 0.06 0.04 Vanguard S&P 500 ETF VOO 60 0.05 21.44 10.25 13.93 – -0.44 0.03 0.04 – Average 123.33 0.06 21.26 10.21 13.89 7.58 -0.03 -0.01 -0.01 -0.03 Median 100 0.05 S o u r c e : author’s own elaboration based on: data source: Morningstar 15.03.2017. What about other types of funds then? Tables 3, 4, 5 and 6 present most popular mutual funds and their ETF alternatives proposed by ETFdb.com Mu- tual Fund to ETF Converter Tool (www.etfdb.com), which utilizes mutual funds benchmarks to find the most corresponding ETFs linked to the same bench- mark. Table 3. Money market ETFs and mutual funds expense ratio and performance comparison Fund Ticker AUM (millions USD) Expense ratio (%) Performance (%) +/- Benchmark (%) 1 Yr 3 Yr 5 Yr 10 Yr 1 Yr 3 Yr 5 Yr 10 Yr Fidelity Cash Reserves FDRXX 1360800 0.37 0.09 0.04 0.03 0.86 -0.29 -0.13 -0.1 0.23 JPMorgan U.S. Government Money Market Fund MJGXX 149400 0.17 0.02 0.01 0.01 0.6 -0.36 -0.16 -0.12 -0.03 GS Financial Squ- are Government Fund FGTXX 92600 0.18 0.34 0.14 0.09 0.72 -0.04 -0.03 -0.04 0.09 Vanguard Federal Money Market Fund VMFXX 71000 0.11 0.35 0.15 0.1 0.73 -0.03 -0.02 -0.03 0.1 low Cost rEtirEmEnt solutions BasEd on roBo-advisors… 85 Fund Ticker AUM (millions USD) Expense ratio (%) Performance (%) +/- Benchmark (%) 1 Yr 3 Yr 5 Yr 10 Yr 1 Yr 3 Yr 5 Yr 10 Yr Wells Fargo Go- vernment Money Market Fund WFGXX 62100 0.13 0.01 0.01 0.01 0.53 -0.37 -0.16 -0.12 -0.1 Average 0.19 0.16 0.07 0.05 0.69 -0.22 -0.10 -0.08 0.06 Median 0.17 USTREAS Treasu- ry Bill Auction Average 3 Month 0.38 0.17 0.13 0.63 PIMCO Enhanced Short Maturity Active Exchange- -Traded Fund MINT 6387 0.35 1.74 2.7 5.06 – 1.36 2.53 4.93 – iShares Short Tre- asury Bond ETF SHV 4620 0.15 0.35 0.15 0.10 0.77 -0.03 -0.02 -0.03 0.14 Guggenheim Enhanced Short Duration ETF GSY 999 0.3 2.06 3.76 6.16 1.68 3.59 6.03 -0.63 PowerShares Treasury Collate- ral Portfolio CLTL 370 0.08 – – – – – – – – SPDR Barclays 1-3 Month T-Bill ETF BIL 180 0.14 0.16 -0.04 -0.17 – -0.22 -0.21 -0.30 – Average 0.20 1.08 1.64 2.79 0.77 0.70 1.47 2.66 -0.25 Median 0.15 S o u r c e : author’s own elaboration based on: data source: Morningstar 15.03.2017. As it can be seen in above table, money market funds and ETFs fees are very similar and neither of them holds the advantage. When it comes to per- formance it’s hard to determine the winner as well. In short and medium term ETFs brings returns better than the benchmark – 3 Months T-Bills average, but in the long term mutual funds beat the benchmark and ETFs brought slightly lower return than 3 Months T-Bills. In terms of portfolio building, money mar- ket funds are rather used in short term, so considering comparable expense ra- tios, both mutual funds and ETFs can be utilized. Table 3. Money market ETFs and mutual funds expense ratio… Kamil Nowak86 Table 4. MSCI US Broad Market Index ETFs and mutual fund expense ratio and performance comparison Fund Ticker AUM (millions USD) Expense ratio (%) Performance (%) +/- Benchmark (%) 1 Yr 3 Yr 5 Yr 10 Yr 1 Yr 3 Yr 5 Yr 10 Yr Vanguard Total Stock Mkt Idx Inv VTSMX 541300 0.15 22.55 9.44 13.59 7.74 4.73 -0.07 0.32 0.21 Fidelity Total Market Index Investor FSTMX 40300 0.1 17.67 9.32 13.09 7.38 -0.15 -0.19 -0.18 -0.15 Schwab Total Stock Market Index SWTSX 5700 0.09 17.67 9.35 13.13 7.48 -0.15 -0.16 -0.14 -0.05 BlackRock Total Stock Market Index Inv A BASMX 596 0.29 17.40 – – – -0.42 – – – Wilshire 5000 Index Fund WFIVX 184 0.67 17.05 9.03 12.62 6.77 -0.77 -0.48 -0.65 -0.76 Average 0.26 18.468 9.285 13.11 7.34 0.64 -0.22 -0.16 -0.19 Median 0.15 MSCI US Broad Market Index 17.82 9.51 13.27 7.53 Vanguard Total Stock Market ETF VTI 76020 0.05 17.68 9.40 13.20 7.74 -0.14 -0.11 -0.07 0.21 iShares Edge MSCI Min Vol USA ETF USMV 12330 0.15 13.66 12.57 13.73 – -4.16 3.06 0.46 – Schwab U.S. Bro- ad Market ETF SCHB 8510 0.03 20.70 10.29 13.37 – 2.88 0.78 0.10 – iShares Core S&P Total U.S. Stock Market ETF ITOT 7860 0.03 17.59 9.83 13.25 7.33 -0.23 0.32 -0.02 -0.20 iShares Russell 3000 ETF IWV 7410 0.2 17.55 9.31 13.09 7.20 -0.27 -0.20 -0.18 -0.33 Average 0.09 17.44 10.28 13.33 7.42 -0.38 0.77 0.06 -0.11 Median 0.05 S o u r c e : author’s own elaboration based on: data source: Morningstar 15.03.2017. Similar conclusions can be drawn from analysis of ETFs and mutual funds, which are tracking MSCI US Broad Market Index regarding the performance trends. In a long term both stays slightly below benchmark level, but it can be low Cost rEtirEmEnt solutions BasEd on roBo-advisors… 87 stated that both accurately tracks MSCI US Broad Market Index. However, aver- age expenses of ETFs are significantly lower than their corresponding mutual funds, so in terms of cost effectiveness in this category ETFs are dominating. Table 5. Barclays Capital U.S. Aggregate Bond Index ETFs and mutual fund expense ratio and performance comparison Fund Ticker AUM (millions USD) Expense ratio (%) Performance (%) +/- Benchmark (%) 1 Yr 3 Yr 5 Yr 10 Yr 1 Yr 3 Yr 5 Yr 10 Yr Vanguard Total Bond Market II VTBIX 120900 0.09 0.45 2.26 1.86 – -0.31 -0.44 -0.47 – American Cen- tury Diversified Bond Inv ADFIX 6500 0.6 0.88 2.51 2.2 4.43 0.12 -0.19 -0.13 0.18 Loomis Sayles In- vestment Grade Bond A LIGRX 6100 0.85 5.32 1.6 3.08 5.52 4.56 -1.1 0.75 1.27 Russell Inv Stra- tegic Bond A RFDAX 5000 0.96 1.32 2.55 2.59 4.25 0.56 -0.15 0.26 0 Wells Fargo Core Bond A MBFAX 4900 0.78 0.73 2.41 2.37 4.6 -0.03 -0.29 0.04 0.35 Average 0.66 1.74 2.27 2.42 4.70 0.98 -0.43 0.09 0.45 Median 0.78 Barclays Capital U.S. Aggregate Bond Index 0.76 2.7 2.33 4.25 iShares Core U.S. Aggregate Bond ETF AGG 42260 0.05 0.21 2.16 1.97 3.93 -0.55 -0.54 -0.36 -0.32 Vanguard Total Bond Market ETF BND 32200 0.06 0.58 2.15 1.99 – -0.18 -0.55 -0.34 – Schwab U.S. Aggregate Bond ETF SCHZ 3410 0.04 0.14 2.11 1.89 – -0.62 -0.59 -0.44 – Average 0.05 0.31 2.14 1.95 3.93 -0.45 -0.56 -0.38 -0.32 Median 0.05 S o u r c e : author’s own elaboration based on: data source: Morningstar 15.03.2017. Comparing funds linked to Barclays Capital U.S. Aggregate Bond Index, ETFs still have significantly lower fees. When it comes to performance and ac- Kamil Nowak88 curacy, mutual funds stay closer to the benchmark and even outperfome it in a long run. Table 6. MSCI All Country World ex-U.S. Index ETFs and mutual fund expense ratio and performance comparison Fund Ticker AUM (millions USD) Expense ratio (%) Performance (%) +/- Benchmark (%) 1 Yr 3 Yr 5 Yr 10 Yr 1 Yr 3 Yr 5 Yr 10 Yr Vanguard Total Intl Stock Index Inv VGTSX 251600 0.18 14.72 2.06 4.73 1.24 0.26 0.45 0.38 -0.08 Harbor Interna- tional Investor HIINX 34500 1.14 8.36 -0.64 3.31 2.09 -6.1 -2.25 -1.04 0.77 Oakmark Interna- tional Investor OAKIX 29500 1 22.68 3.07 8.83 4.55 8.22 1.46 4.48 3.23 Fidelity Inter- national Index Investor FSIIX 16300 0.2 12.32 1.29 5.75 1.04 -2.14 -0.32 1.4 -0.28 American Funds Intl Gr and Inc A IGAAX 11200 0.91 12.36 -0.47 4.85 – -2.1 -2.08 0.5 – Average 0.69 14.09 1.06 5.49 2.23 -0.37 -0.55 1.14 0.91 Median 0.91 MSCI All Country World ex-U.S. Index 14.46 1.61 4.35 1.32 iShares MSCI ACWI ex U.S. ETF ACWX 2070 0.33 12.27 1.14 3.59 – -2.19 -0.47 -0.76 – SPDR MSCI ACWI ex-US ETF CWI 1210 0.3 12.77 1.77 4.07 1.83 -1.69 0.16 -0.28 0.51 Average 0.56 12.52 1.46 3.83 1.58 -1.94 -0.16 -0.52 0.51 Median 0.32 S o u r c e : author’s own elaboration based on: data source: Morningstar 15.03.2017. Going back to equity funds, but outside the U.S market this time, once more it can be noticed that expenses of ETFs are lower than mutual funds. Aver- age ETFs fees are 0.13% lower than mutual funds. To sum up above analysis, US market and international equity ETFs expense ratio is usually significant- ly lower than their corresponding mutual funds. Bond ETFs fees are hard to beat as well. While in case of money market, both types of investment vehicles low Cost rEtirEmEnt solutions BasEd on roBo-advisors… 89 are competitive in terms of expense ratio. Based on figure 3, which shows how a small difference in fees can impact future retirement, choosing ETFs instead of traditional mutual funds to compose long term retirement portfolio, can bring significant savings. Going further, retirement portfolio based on ETFs will result in higher retirement than portfolio based on mutual funds. Rise of robo-advisors Technology has a huge impact on all the industries including finance. Imple- mentation of FinTech solutions resulted in rise of robo-advisors, which is a common term for digital investment advisory. In other words, it’s automat- ed investment advisory and portfolio management service with minimal, or no human intervention. Robo-advisors provide internet services using algo- rithmic portfolio strategies. Based on online questionnaire filled out by an in- vestor, the algorithm assesses customer’s risk tolerance and gathers informa- tion to understand client’s needs and investment preferences. Knowing user’s investment goals and risk profile, assets allocation can be made and portfo- lio recommendation are presented. After the investment is placed, digital ad- visors offer portfolio management as well. Customer receives frequently up- dates, alerts and market research. To adjust to investment goals and client’s preferences, algorithm provides periodically portfolio review and rebalancing when needed. Robo-advisory is a fast growing segment of assets management business. Regarding to statista.com (www.statista.com) business of robos will grow from 500 bn US dollars in 2016 to 2.2 trillion US dollars in 2020. Booming popularity comes from four major benefits of digital advice: ■ Efficient investment management – robo advisory platforms are based on algorithms that provide automated portfolio rebalancing. No custo- mer action is required. What is more, automation eliminates common human investment decision’s biases. ■ Transparency and accessibility – digital advisory platforms are trans- parent and user friendly. Internet platforms or even mobile applications allows to track the investments 24/7. Even not very sophisticated inve- stors are able to analyze the return and compare it vs benchmark. ■ Diversification – system captures the customers’ investment objectives, time horizon and attitude to risk. Based on investors’ preferences algo- rithm adheres to modern portfolio theory which manages risk exposure through portfolio diversification, investing in low costs ETFs. Kamil Nowak90 ■ Lower fees and lower minimum investment requirements than traditio- nal asset managers attract investors, who don’t qualify to be served by traditional institutions (France-Massey, 2016, p. 29). Robos’ fees are significantly lower than traditional asset managers. Typi- cally, all the expenses are not higher than 1% of AUM, but same advisors of- fer fees as low as zero. How is it possible to charge customers with so low fees and still keep the business profitable? Of course thanks to technology, which not only empowers portfolio allocations and investment management, but im- pacts record keeping, compliance reviews and periodical rebalancing. Process- es, which in case of traditional asset management company represent signifi- cant share of operation costs, can be fully automated and fewer personnel is required. Thanks to significant cost reduction digital advisors can operate at much lower costs and those savings can be passed on to the investors (Xia, 2016). Another advantage of robo advisors, which attracts customers is trans- parency of the fees. Investors have to pay only one annual management fee and ETF fees on the assets they hold. Table 7 compares 10 top US robo advisors. Breaking the list by assets, it is obvious that, 2 firms are dominating the mar- ket, both owned by traditional asset managers – Vanguard and Schwab. What is more, the sixth biggest firm Future Advisors belongs to BlackRock. All of the robos offers mostly ETFs of well known providers. Most of the portfolios are rebalanced automatically on contribution, withdrawal, dividends and when- ever allocations drift from their target. Setting up the account is easy. All of the platforms allows to open the account online. Minimum balance required to open the account can be as low as $0 for some advisors. What makes investing even more accessible for beginner investors. ‘Fees’ is of course the most inter- esting column. They vary from 0.1% to 0.5%. It can be noticed that higher fees are usually correlated with high human interference, so savvy investors should choose rather fully automated platforms. Tax-loss harvesting may be as impor- tant as the fees, because when provided on daily basis, it can boost annual re- turn by even 2%. On the other hand, Table 8 presents average financial advisor fees. Of course they are much higher than robos’. FA’s fees can decline below 1% only for larger than 1 million USD. Table 7. Top US Robo advisors characteristics Firm AUM (millions USD) Human touch Portfolio Rebalancing Tax-loss harvesting Fees Account minimum Vanguard Personal Advisor Services 47,000 High Vanguard mutual funds, ETFs Quarterly On case by case basis 0,30% for portfo- lios below $5M, above $5M fees drop by tier, low- est fee 0,05% for portfolios larger than $25M $50,000 Schwab Intel- ligent Portfolios 12,300 Low Schwab and third party ETFs Automatic, daily For ac- counts of $50,000 or more 0,1% under $100M no charge above $100M $5,000 Better- ment 6,700 Low Vanguard and iShares ETFs Automatic, whenever alloca- tions drift 3% from the target Daily on all accounts 0,15-0,35% …. $0 Wealth- front 4,348 Low Vanguard, Schwab, iShares and SPDR ETFs Automatic, whenever alloca- tions drift from the target Daily on all accounts No charge for first $10,000 Above $10,000 flat 0,25% $500 Personal Capital 2,835 High ETFs and for portfolios above $100,000 indi- vidual stocks On all accounts On all ac- counts 0,49-0,89% $25,000 Future Advisor 969 Me- dium iShares, Van- guard and SPDR ETFs 4-6 times an- nually On all ac- counts 0,50% $10,000 Rebal- ance IRA 403 High Vanguard, iShares and SPDR ETFs Automatic On all ac- counts 0,50% $100,000 Acorns 257 Low Vanguard and iShares ETFs Automatic, whenever alloca- tions drift 5% from the target No $1 monthly below $5,000 above $5,000 flat 0,25% no fees for col- lege students $0 Etrade Adaptive Portfolio 180 Low Vanguard, iShares and SPDR ETFs, active mutual funds Automatic, daily No 0,30% $10,000 SigFig 114 Low Vanguard, iShares and Schwab ETFs Automatic, daily On all ac- counts No charge below $10,000 Above $10,000 flat 0,25% $2,000 S o u r c e : author’s own elaboration based on: data source: www.etf.com (accessed:15.03.2017). Kamil Nowak92 Table 8. Average Financial Advisor Fees Investment Amounts Average Advisor Fees (%) $50,000 1.18% $100,000 1.12% $150,000 1.09% $250,000 1.07% $500,000 1.05% $1,000,000 1.02% $1,500,000 0.94% $2,000,000 0.91% $2,500,000 0.88% $5,000,000 0.84% $7,500,000 0.77% $10,000,000 0.69% $20,000,000 0.65% $30,000,000 0.59% S o u r c e : Average Financial Advisor Fees & Costs 2017 Report, www.advisoryhq.com (accessed: 15.03.2017). The outcome of the research process and conclusions Considering American retirement system challenges: low savings rates, shift- ing contribution responsibility from employer to employee, low IRA return rates, new solutions are more than desired. What is more, high management and fund fees are banes for investors. If changing retirement policies and reg- ulations might not be an option, the cure for the system should be find in low cost retirement solutions. This paper proofs that replacing traditional mutual funds with ETFs can bring significant savings in fees, without impacting the performance. Choosing equity S&P500 ETFs over mutual funds saves 0.45% in fees annually. What is more, if traditional FA will be replaced by robo advi- sor, additional savings can be made. Taking in consideration $100,000 portfo- lio, shift to digital advice saves 0.87% in fees. Combining robo advisors savings with those brought by ETFs, potentially 1.32% annually can be saved, what brings $1,320, that can remain on the account. Considering usually more than low Cost rEtirEmEnt solutions BasEd on roBo-advisors… 93 30 years investment horizon and instant growth of the portfolio, savings can be tremendous. ETFs are on the market for more than 20 years right now. Fur- ther steady growth of this segment probably will result in displacing mutual funds. The future of robo advisors looks bright as well. Digital advice will be- come a new standard for mass aff luent customers. Not only American retire- ment system needs new solutions. Polish retirement system has own challeng- es as well. Poles social awareness of retirement issues and trust to government institutions is very low. One of the youngest in Europe retirement age connect- ed with demographical challenges and lately disassembly of OFE brought a gap in Polish retirement system which hasn’t been filled yet. Return rates of retire- ment solutions offered by mutual funds are mostly eaten up by fees. What is more, currently on GPW only 3 ETFs are listed and no digital advisory platform is available in Poland. Considering above arguments, there is definitely a niche for innovative low cost retirement solutions and further research on that topic.  References Aubry, J., Crawford, C., & Munnell, A. (2015). Investment returns: Defined Benefit vs. De- fined Contribution Plans, Center for Retirement Research Boston College. 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