The number of financial services companies that provide online investment management and financial planning has increased exponentially over the last few years. Also known as robo-advisors, these companies are able to leverage technology to reduce the costs and lower account minimums, making financial planning and investment management more affordable than it’s ever been for many lower and middle-class families.
Yet though online financial advisors are granting access to such services to millions of Americans who were previously unable to afford them, they aren’t for everyone. Here are three things to consider before using an online advisor. (For related reading, see: Do Robo-Advisors Really Act in Your Best Interest?)
Know What Services You Want
Are you looking for an investment manager, or a financial planner? Most firms that provide online financial advice are only providing investment management services. While some of these companies incorporate very basic tax savings and portfolio management strategies such as tax-loss harvesting and periodic rebalancing, they do not include advice on important financial planning topics such as income tax planning, insurance planning, estate planning, employee benefits, and cash flow modeling.
Morningstar has conducted research that estimates the value of using a financial planner has the same impact on expected utility as an annual arithmetic return increase of 1.59% per year, which can add far more alpha than portfolio management alone. If your goal is to grow your retirement investments using only the answers to a risk questionnaire as the basis of your investment decisions, then an online investment manager may be for you. However, if you are looking for a more customized portfolio, which uses value-added financial planning as the basis of your investment decisions, make sure you are hiring a financial planner. (For related reading, see: What You Need to Know About an Emergency Fund.)
Do You Have Access to a CFP?
There is some comfort in being able to talk to an actual person to make sure you are on the right track rather than relying on a computer algorithm to make sure you are taking all the right steps necessary to achieve your goals. If financial planning is important to you, you should have access to a certified financial planner (CFP), whose designation is the standard of excellence in financial planning. Other than ensuring a human is periodically looking over your situation, having access to a CFP can provide many intangible benefits such as being able to talk to someone in times of uncertainty. There are only a few online advisory firms that grant access to a CFP.
Also, if you are going to use the services of these firms, it’s important to know how many clients each advisor is serving. Can an advisor servicing 500 to 1,000 clients remember your goals, and unique circumstances affecting your financial plan? If you’re in need of assistance, what would be the response time? If you’re looking for an advisor who will be able to remember your unique situation, he or she should be serving no more than 200 clients.
Do You Need More Than Generic Advice?
Are you in need of complex tax, insurance, or estate planning strategies? If you are a high-income earner, have accumulated a significant amount of wealth or own a business, the answer to this question is probably yes. Because online advisors have utilized technology to automate financial planning and investment analysis, many of the recommendations will be generic cookie-cutter advice. This is sufficient if you have basic needs, but if you are in need of more customized analysis and recommendations, you may be best served by using a CFP.
Online advisory firms are a great tool for many Americans who haven’t ever had affordable access to financial planning and investment management. These services can take care of the basics, but they are not focused on adding extra value to your unique situation. If you do end up using the services of an online planner, it’s important to understand that you are reducing the cost of these services by limiting customization—and access to your advisor. (For more from this author, see: 6 Steps to Prepare Financially for a Newborn.)