Robo-advisors are a digital platform that uses algorithms to act as an automated, low-cost alternative to traditional financial advisors. The best ones offer help with asset allocation, rebalancing, portfolio management, and even tax-loss harvesting. They’re the darling of the investing world, but are they right for you?
In the early 2000s, industry insiders started using algorithms as the pre-curser to robo-advisors to help with their clients. There was no low-cost option for the average investor because this technology was unavailable.
Today we’ll discuss the pros and cons of robo-advisors, how they compare, and whether they’re something you should consider.
Robo-Advisors vs. Financial Advisors
Are they able to adequately replace financial advisors? There are a few things to look at: fees, account minimums, and financial advice.
Fees and Account Minimums
Robo-advisors have a massive advantage over financial advisors because of the low fees they charge. It’s not uncommon for a financial advisor to charge 1-2% of the total account balance in fees.
A typical Robo-Advisor will charge between 0.2%-0.5%. No human advisor is figuring out the perfect asset allocation for your investment portfolio, so the expense ratio is naturally going to be much lower.
Even a 1% fee can have a massive impact on your portfolio.Tweet This
In addition to higher fees, most financial advisors have an account minimum you have to hit to use their services. However, robo-advisors, such as Betterment Digital, have no account minimum.
Those that do have an account minimum set the bar substantially lower than human financial advisors.
Personal Financial Advice
Even the best ones can’t offer the necessary human interaction of a financial advisor. A financial advisor can look you in the eye and provide personal advice.
The best a Robo-Advisor can offer is relatively specific albeit general financial guidance.
You’re getting an algorithm-based investment approach with a Robo-Advisor. With a financial advisor, you’re getting a tailor-made personal investment strategy.
Robo-advisors also have the benefit of being uncaring and data-driven. It might sound like a drawback, but consider the financial advisor who has missed on a few stock market prospects and feels the need to take a gamble to win big.
A financial advisor has to worry about keeping their job, and sometimes their risk tolerance might not line up with yours. Robo-advisors concentrate only on what’s statistically the best decision.
On the flip-side, a financial advisor is worth their weight in gold when they keep you from panicking and selling at the bottom.
Covid-19 wreaked havoc on the stock market in late February. A lot of people panicked and sold right before the market started climbing back up.
A good financial advisor can calm your nerves and keep you from sinking your own ship.
If a financial advisor had the same expense ratio as a Robo-Advisor, they’d win out. But that’s not real life. Robo-advisors charge a fraction of the cost to handle your investment portfolio compared to a human advisor.
Ideally, you’d get the lower cost of a Robo-Advisor but still have the option to talk with a real person from time to time. Which leads me to another choice.
Robo-Advisor Hybrid Options
A few companies, such as Charles Schwab and Vanguard offer a hybrid model where a Robo-Advisor does the day to day wealth management of your portfolio, but you have access to a real human investment advisor.
This marries the two competing camps and gives investors the best of both worlds. You don’t need human advice 95% of the time, you just need to know what the numbers say.
Every once in awhile, it’s nice to get the reassurance of a certified financial planner.
The Charles Schwab Intelligent Portfolio will build, monitor, and rebalance a portfolio based on your financial goals.
The account minimum is $5,000 for its general service, or $25,000 if you want access to certified financial planners.
They’re unique in that they charge a subscription fee of $30/month but they charge no management fees.
Vanguard Personal Advisor Services offer many of the same perks with a fee of only 0.30% but the minimum balance needed is $50,000.
Betterment’s top-tier service, Betterment Premium, combines all the Robo-Advisor services of their Betterment Digital but includes unlimited phone access to certified financial planners (CFP).
You can access this service for a fee of 0.40% of assets under management (AUM) and an account minimum of $100,000.
If you like the idea of a lower cost Robo-Advisor, but want access to real humans from time to time, then the above hybrid options might be for you.
If you’re considering which Robo-Advisor to use, read our post The Best Robo-Advisor: 13 Distinguished Picks for You This Year.
Robo-Advisors vs. DIY
Perhaps you’ve decided the management fees of a financial advisor just aren’t worth it. If you plan to buy and hold exchange-traded funds (ETFs) or mutual funds, it can be hard to justify the expense ratio of a financial advisor.
Depending on your risk tolerance, and your aptitude for personal finance, you can probably do as good or better managing your investments compared to a Robo-Advisor.
It becomes a question of time management and whether the juice is worth the squeeze. For most of us, robo-advisors are inexpensive enough that it’s not worth the time and effort it would take to handle our own investment accounts.
That being said, some people want to be more hands-on with their investment management. If you want to set it and forget it, then go with a Robo-Advisor.
If your risk tolerance is higher and you enjoy the thrill of trying to beat the market, you’ll probably prefer a DIY approach.
Using a Robo-Advisor is like getting around town on a bicycle. A DIY approach is like walking. Both will get you where you’re going but the bicycle is probably a better use of your time.
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Robo-Advisors vs. Index Funds
There is a way to DIY your investment portfolio without spending a bunch of time. A lot of investors who don’t want to pay a financial advisor opt to invest in low-cost index funds.
Purchasing index funds through Vanguard, or whatever brokerage you prefer, is a great way to build long term wealth and reach your financial goals. The idea of this lower-cost option is you buy and hold.
Don’t worry about stock market fluctuations or what the next great company will be. You simply invest in low-cost index funds with the goal of matching the market and forget about it. Easy.
The downside to this approach is you don’t get any of the other Robo-Advisor services such as portfolio rebalancing, tax-loss harvesting, or help with asset allocation.
The upside is you get to control your own investments, save money, and it won’t take a whole lot of time out of your day.
Pros and Cons
The main benefit of robo-advisors is the ability to combine data-driven financial planning and automated investing while charging lower fees than human financial advisors.
In addition to the lower cost, robo-advisors are more convenient. You can log on anytime and check your account. You’re not limited to the 9-5, Monday-Friday schedule of human financial advisors.
One downside is their inability to be as nuanced as a person. Each financial situation is different and a Robo-Advisor might not have all the information needed to help you make an informed decision.
Plus, sometimes it’s nice to look someone in the eye and have them tell you it will be okay.
In today’s digital world, more and more companies are rolling out robo-advisor options. They compete for your attention and loyalty which makes consumers the real winners.
Is a Robo-Advisor Right for You?
Choosing a Robo-Advisor over these other options comes down to personal preference. The best robo-advisors use modern portfolio theory, which is a mathematical framework.
It constructs the lowest risk and highest returning investment portfolios that span multiple asset classes.
For new investors, it can make sense to leave investment decisions up to the Robo-Advisor’s algorithm. Once you have a higher account balance, it might make sense to switch to a premium service.
For example, Betterment Premium offers all the perks of a regular Robo-Advisor but gives you access to certified financial planners, investment guidance, and keeps you on the right track.
If you have complicated retirement accounts and aren’t as concerned about the fees, then hiring a full-time financial advisor might be your best move.
A 1%-2% fee on your earnings can kill your overall returns, so make sure you’re getting your money’s worth if you make this decision.
Personal Capital’s Fee Analyzer is a great tool that can help you figure out which option is best for you. Blooom can help analyze your portfolio to make sure you’re getting the most out of your retirement accounts.