Are you confused whether you should use a robo advisor? Learn the pros and cons in this article to make the right decision.
In this article:
- What Is a Robo Advisor?
- How Does a Robo Advisor Work?
- Target-Date Funds vs Robo Advisors Comparison
- Is a Robo Advisor Worth It?
- How to Evaluate if Robo Investing Is Right for You
Robo Advisor | Is It the Right Option for Investors?
What Is a Robo Advisor?
Chances are high that if you have an interest in the stock market, you’ve heard of or have already dealt with robo advisors. The jury’s still out, though, on whether it’s a reliable, scalable, and automated system.
Here’s everything you need to know, plus additional things to consider, before engaging in a strategy with robo advisors.
A robo advisor is an online, automated investment platform that helps in financial planning and wealth management. In other words, it tends to work like a financial advisor.
Some of the roles it plays include:
- Creating your investment portfolios
- Managing the day-to-day responsibilities of investing
- Periodically rebalancing investments
One of the attractive features of the technology is tax-loss harvesting. It is a process that aims to offset capital gains taxes by selling other securities at a loss.
Some robo advisors also mitigate capital gains earnings and, as a result, capital gains taxes by selecting a blend of investment types that either does not pay dividends or has a structure that can delay capital gains earnings.
To ensure the best investment and tax strategy, ask yourself how important it is for you to have an actual human advisor to call when you need. Make the best decision for your level of tolerance and communication tendencies.
Regardless, according to Money, the total assets held and managed by robo advisors at the end of 2017 reached $222 billion—more than double 2016’s figure.
With numbers like these, it is clear robo investing is likely not just another fleeting tech trend. It’s a new investment strategy that’s not going away anytime soon.
How Does a Robo Advisor Work?
Investment management with a robo advisor begins with a short questionnaire. It assesses the investor’s tolerance and goals.
Some of the topics covered include:
- How long you intend to invest
- Target retirement date
- Investment objectives
- How willing you are to put money into volatile investments
Once the robo advisor determines your investment profile, it proceeds to portfolio management. It divides your money into various investments it “thinks” suit your answers.
Meanwhile, to open an account, you simply need to make an initial deposit.
Target-Date Funds vs Robo Advisors Comparison
Some people may confuse robo advisors with target-date funds since their principles are similar.
You can use both for short- and long-term investment. They can also involve management fees and are both automated processes.
The significant difference lies in the types of funds they handle and the way they automate investing.
A robo advisor usually works with ETFs while target-date funds deal with mutual funds. The latter also follows what experts call the “glide path,” which is a formula used in strategizing asset allocation based on the time left before the target date.
Here’s a sample scenario to explain this concept:
- An investor is in the process of deciding when they want to withdraw their investments, which is usually their year of retirement.
- As the person grows older, the fund may adjust where it places the money to maximize growth in the remaining years.
Is a Robo Advisor Worth It?
Are robo advisors worth it? The answer is yes—for certain aspects. Consider the following:
Pros of Robo Advisors
1. Ease of Use
A robo advisor can be a great option for an individual new to investing or an investor who hasn’t found the right human advisor yet. Many of the options today such as Betterment and Wealthfront are beautifully designed and easy to use.
They can take the guesswork out of the investment process. This doesn’t mean, though, that one doesn’t need to learn the basics.
It just means that foundational knowledge on investing may be enough to help anyone grow their personal capital efficiently with the help of a robo advisor.
2. Lower Costs and Potential for Higher Total Returns
Robo investors can also help clients who don’t want to spend too much on management fees on advisory services.
Although the upfront costs of investing with a robo advisor ring in slightly higher than self-managing one’s own investments, they’re typically much lower than investing with financial advisors. Robo advisors may charge as much as four times less than a human advisor.
For a better picture, compare robo advisors vs. financial advisors when it comes to cost.
A financial advisor can charge a client the following:
- Fixed fee, which is usually from creating a financial plan
- Hourly charges, depending on the frequency and duration of every consultation
- Percentage of commission or earnings each time the investments generate income
- Fees depending on the percentage of assets under management
- Additional charges, such as performance-based bonus
Scenario #1: Hiring a Human Advisor
On average, a person who hires a financial advisor may spend at least $1,500 in the beginning. This may turn off some investors who don’t have that kind of money right off the bat, especially if they’re younger.
Note that, as the individual ages, their financial decisions and situations can also change. Take, for instance, someone nearing the age of retirement.
Financial advisors may begin to specialize in estate planning or retirement investment growth. They may look for assets or portfolios that can now provide the highest possible returns due to the limited time.
Scenario #2: Hiring a Robo Advisor
Using a robo advisor also entails paying a fee, but an investor can begin to invest for as low as $500. Betterment doesn’t even have an account minimum.
Even if an individual takes into account the other charges, they usually don’t come near the cost of hiring a financial advisor. The only time it happens is when the account is already large, to begin with. By then, it means the clients are already high-net-worth individuals.
The top robo advisors may also provide an all-in cost to make all these fees easier to understand.
3. Ideal for Millennials
It may also be ideal for those who are more tech-savvy or those who do not have a lot of money to invest, such as the millennials.
Who are the Millennials? Also known as Generation Y, these are the people born during the early 80s until the late 90s.
Why do millennials matter? They account for a significant portion of the country’s workforce.
They now have an influence on investing and even the future economy. There’s no better time to teach them how to be financially independent than today.
These platforms can appeal to them because of their exposure to the Internet. This tech-savviness can also come in handy as they can quickly read online reviews for the best robo advisors.
Robo advisors can provide tools to make investing easier, including real-time alerts for any market changes.
The lower fees also make robo advisors ideal for millennials. Unlike the older generation, millennials are still building their nest egg.
They may be saddled with other payments, such as student loans. Thus, they may not necessarily have the means to hire professionals for investment management.
In conclusion, robo advising makes investing simpler and more affordable, even for a beginner. It offers automatic investing options, low fees, and an overall simplified process.
This combination of affordability and ease attracts many beginning investors.
Cons of Robo Advisors — The Downsides of Robo Investing
In spite of offering a cheap price tag and easy access, robo advisors may not be the best fit for everyone. In reality, investing can cost more than the upfront fees when you consider earning potential or lost earning potential.
The true cost of investment depends on where the person decides to park their money.
Perhaps the biggest drawback to a robo advisor is the lack of flexibility and control regarding the asset allocation it offers investors.
Robo advisors can focus heavily on exchange-traded funds (ETFs) due to their low costs and tax efficiency. This can hinder a portfolio’s diversity and flexibility.
They can also provide limited account choices. Some robo advisors neglect to offer options for retirement and taxable accounts, such as individual retirement accounts (IRAs) and 401(k)s.
Although they encourage some diversification, a robo advisor usually only offers three “styles” for investing depending on the investor’s tolerance for complexity.
Another downside is the robo advisor’s lack of empathy and humanity. While this works to its advantage in terms of investing without fear or greed, it can also fail in reassuring panicked investors or those in special circumstances, such as instability in job security.
How to Evaluate if Robo Investing Is Right for You
Whether a robo advisor or a financial planner is the right choice for you depends on a few factors:
- Dollar amount of your investments—A large nest egg can give you access to a greater selection of investment options than robo advising can offer.
- Types of retirement accounts you have—Most robo advisors do not provide options for many types of retirement accounts.
- Flexibility you want regarding investments—A robo advisor leaves the investor little to no control over investment allocation.
- How much free time you have—A robo advisor saves individuals a lot of time when it comes to researching and managing investments. Without putting in the time and effort, however, investors can miss out on major opportunities and lose potential investment gains.
- Proximity to the age of retirement—As you near retirement (or if you are already retired), you can enjoy greater flexibility regarding asset allocation. The ability to move funds into investments that can allow you to live off earnings will enable you to delay Social Security collection and increase the amount you eventually receive later.
A robo advisor may be a sound option for those who need a nice entrance into the world of investing. It can make things much easier to deal with. The platform can give a taste for what to expect.
It is equally helpful to learn more about self-directed investments. This method gives you greater control over asset allocation and earnings.
Most of all, it is always better to get financial advice from seasoned investment advisors before trying to do it all yourself. They are the ones who can truly address your concerns and customize your investment strategies to your needs.
What do you think of using a robo advisor? Is it something you want to use? Share your thoughts in the comments section below.
- The Best Investment Calculator To Use For Retirement Planning | Inside Your IRA
- How to Plan for Retirement by Growing Your Investments | Inside Your IRA
- 2019 Roth IRA Withdrawal Rules [INFOGRAPHIC] | Inside Your IRA
Editor’s Note: This post was originally published on August 21, 2018, and has been updated for quality and relevancy.