What are robo advisors? They’re the shiny new object of the investment world. Here are 6 reasons to like them, as well as 5 reasons not to. Are they worth it? It’s not as black-and-white as you might think, but here’s our conclusion.
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What are robo advisors? They’re the shiny new object of the investment world… the new kid on the investment block.
These robots are a class of “investment managers” that operate from complicated computer algorithms. They seek to automate the investment process. Not surprisingly they often appeal to young tech-savvy people with lower investment amounts.
The world’s first robo advisor, Betterment, launched in 2014. Its aim was to serve people who lacked the 5-, 6-, or 7-figure asset minimums to interest a skilled human financial advisor.
What are Robo Advisors? A Platform for Tech Savvy Investors
Robo advisors took advantage of tech advances and market structure that allowed low-cost, effective investing with low starting balances.
From a tech viewpoint, robo advisors’ use of algorithms in trading, mobile apps, and digital signatures means a much simpler account opening process with less paperwork. Their computers can execute trades flawlessly and monitor portfolios nonstop – neither of which a human financial advisor can do on a broad basis.
Some robo advisors are 100% automated. Others also offer access to real humans as an upgrade. (Glad to know that I, as a human, am an “upgrade.”)
Every robo advisors’ overriding claim is that their proprietary algorithm is “the best” at removing emotion from investing. So therefore they offer the best returns. But truthfully, every robo-advisor can’t possibly have “the best” proprietary algorithm. That’s impossible.
So what are robo advisors’ advantages and disadvantages?
Let’s take a peek under the hood and see not only what are robo advisors… but who robo-advisors are right for. And who should avoid them. Then you can make your own educated decision.
Robo Advisors – The Advantages
1. Low minimum balances.
Robo advisors are a boon for beginner investors. They give access to investment advice with low initial balances.
You can get started with no minimum balance at Betterment, Folio Investing, and Axos Invest. Some robo-advisors require $1,000 to $5,000 to start. Personal Capital is free for portfolio monitoring, with fees for access to more individualized financial planning.
If you’re tech-savvy, robo advisors can help you if you have low initial investment amounts. After all, it can be hard to rub two nickels together when you’re just getting started in adult life.
I’m a big fan of automating your finances to the greatest degree possible. One single action to set things up then becomes your ongoing decision… without a trace of time or trouble on your part.
Robo advisors can help automate the decision-making involved with investing.
3. Low fees.
Before robo-advisors were a thing, investors were lucky to find professional management of assets for less than 1% of assets under management (AUM). Robos disrupted that model.
Today you can get zero-cost robo advisors from Charles Schwab’s Intelligent Portfolios, and 0.25% for ongoing portfolio management from Betterment (first year is free) and Wealthfront… all of which appeal to many cost-conscious investors of all ages.
4. Ease of use.
Robo advisors have beautiful web interfaces, on both computer and phone. They also make it easy to transfer money and start investing. To tech-savvy folks, that’s a real godsend.
5. New “hybrid” options.
More and more, traditional financial planners are white-labeling robo advisors for their clients. Meaning that you can get the best of both worlds – a real person to talk with for lower fees than the traditional 1% AUM model, plus automated investing through the robo advisor platform.
6. Based on Nobel Prize-winning investment models.
Many robo advisor algorithms, including Betterment’s, rely on best practices investment theory to build portfolios with the best returns at the smallest risk.[i] This is based on the research of 1990 Nobel Prize winner Harry Markowitz and 2013 co-winners Fama and Shiller.
Eugene Fama helped develop a product to mirror market performance – the index fund.
Robert Shiller gave us a clearer picture of investor emotions and how they behave in real life.
Robo-Advisors – The Disadvantages
On the flip side, robo-advisors have their disadvantages (like all things in life). Here’s the downside to know about.
1. Robo advisors are inhuman and impersonal (so far).
You’re a real human being, not an investment portfolio. No doubt you have goals and dreams, both near-term and long-term. Sure, some robo-advisors let you set and edit your goals. But every now and then it’s reassuring to sit down and talk with a real human being.
Most robo advisors won’t hold your hand or talk you off the ledge during a market panic, or after the untimely death of a loved one.
What’s more, a human financial planner helps integrate the many faces of your money life – your finances, investments, taxes, and estate plans. Robo advisors do not.
2. Robo advisors can be limiting.
If you want to buy individual stocks or call options, it’s beyond the limited scope of most robo-advisors. So a robo advisor is not suitable for those types of sophisticated investors.
3. Robo advisors claim to be the only resource for the little guy or gal. (Not true.)
In reality, there are many options out there for those just getting started in investing.
For example, a fee-only advisory service by Certified Financial Planner® (CFP) fiduciaries called the XY Planning Network caters to younger investors. It offers an affordable pay structure. Even then, you should be asking if you even need a financial advisor at this point.
Also, there are numerous index funds that track the market that are extremely cost-effective. They’re simple and easy to own, and don’t require a financial advisor (either human or robo advisor) to get going.
4. Some robo advisors make disingenuous claims.
Things like touting “tax loss harvesting” as a big advantage, when it’s an infinitesimally small aspect of investing. Tax loss harvesting means you sell an investment that’s down, in order to offset tax gains. It might save you a little money over the long haul. The operative word being, little.
It’s a “nice to have” feature, but it’s hardly worth choosing an advisor on or (probably) paying money for.
5. Robo advisor market pressure drives the use of marketing gimmicks.
Robo-advisor’s super-low fees – less than 0.4% – means that in order to run a sustainable business they must keep offering increasingly expensive features, and attract massive amounts of new business. Like in the trillions of accounts.
New robo-advisors often have trouble sustaining their business model on such low fees unless they can rapidly scale. Which they’re unlikely to succeed at.
Or else, they may turn to venture capital investors, who demand crazy fast growth. Some robo-advisors charge higher fees to offset this weakness. Marketing gimmicks and higher fees are the predictable outcomes of venture capital investors. After all, to remain viable, they have to find ways to extract more money from each customer. Customers like you.
Otherwise, they’re forced to either merge with bigger players or shut their doors.
Are Robo Advisors Worth the Hype?
Robo advisors emerged to serve a previously ignored audience – digitally savvy, upwardly mobile, affluent professionals who may not want to actually meet face-to-face with a human advisor. But you have to ask if they’re worth the hype.
Given robo advisors’ propensity to raise fees, claims of enrolling customers into their “risk-parity” hedge fund unawares, and lack of individualized advice, their fees may not justify their offerings. At least not for some people.
Schwab gets the edge, in my book. They do offer a broad spectrum – including a robo advisor (Schwab Intelligent Portfolios), personal advisors, and a blend of the two. All for a low cost of entry to get in the game. Plus fractional shares.
Or, just invest in an index fund, let it grow, and when you’re at the point where you need solid advice, get in touch with a live CFP advisor to discuss your finances.
Here’s the Bottom Line…
Really, by the time you choose any of these types of financial advisors (robo advisor, fee-only CFP®, blended option, discount brokerage…), you’re 90% of the way to getting started doing something!
And that means you’re starting to grow your money in low-cost investments for the long term. Which is far better than wallowing in indecisiveness and staying poor.
Getting started is a key part of making your wallet “wise” so you can live your dreams. You’ll never hit your financial (or dream!) success without hitting the “start” button.
It’s like NASCAR drivers starting their engines for the race. What are the odds they’ll win if they never start their engines? Zero, zippo.
So whether you opt for a robo-advisor, Schwab, or some other low-fee brokerage is really a mute detail that depends on your interests (stock-picking?), investment savvy, and starting price point.
Just pick one of them, and get your wealth-building on. Today.
[i] Betterment. “Noble-Prize Winning Investing.” https://www.betterment.com/resources/nobel-prize-winning-investing/. Accessed September 15, 2020.