Are you interested in a simple, low-cost financial management approach?
If so you might be interested in robo-advisors, which is shorthand for automated investment portfolios that use algorithms to help you invest (generally with ETFs), save for retirement, minimize taxes and provide a variety of other services generally for a small fee. These emerging investing management platforms come in a variety of shapes, sizes, and specialties. Understand the advantages and disadvantages of these unique investment platforms and how they match up with the traditional investment advisory landscape, and you’ll be a better-informed investor.
What's a Robo-Advisor?
Robo-advisors are not all alike, but they do have some traits in common. In general, these types of advisors use technology and sophisticated investment management algorithms to deliver lower cost (in most cases) automated investing platforms to the public. Although some of these newer advisors also offer a human touch, many are completely automated. Some are more or less tailored for wealthier investors, and some are for beginners. The client usually stays in touch with the technology assisted advisor through email, phone or video chat instead of face to face meetings, as is frequently the custom with traditional financial advisors. (For a list of robo-advisors, click here.)
There are dozens of robo-advisors at present offering a variety of services to both individual savers/investors and financial advisors some of the big names are Betterment, Wealthfront, SigFig, LearnVest and Betterment. There are even some Fintech companies that are considered 'robot-related,' meaning that they have some of the characteristics of robo-advisors but only offer a narrow set of services, such as account information aggregation.
How Do Robo-Advisors Work?
Robo-advisor business models, services, and costs all differ.
For example, Jemstep (which was acquired by asset manager Invesco Ltd. in January 2016) offers robo-advisor platforms to advisers rather than managing assets of individuals. Such B2B robo-advisors provide financial advisors with a platform to utilize automated portfolios, services, and tools to serve clients of all asset levels. (For related reading, see: How Technology Helps Financial Advisors.)
Wealthfront is one of the largest new entrants into the market. They also have a free option for smaller portfolios and then charge a small percentage to manage the greater asset sizes. This automated system invests in tax-efficient index funds and regularly rebalances to maximize returns and reduce risk. It also offers tax-loss harvesting.
Personal Capital, founded by Bill Harris of Intuit and PayPal fame, uses a combination of automated investments and access to a pool of specially trained financial advisors. This platform has a useful dashboard which gives the investor the opportunity to manage his or her entire financial life in one place (banking, bills, retirement savings, etc.). Comparable to the previous examples there is a free and paid option. Many people consider it a better platform for wealthier investors rather than beginners.
Betterment is an automated goal-based investing service with no investment minimum, which makes it especially attractive to beginner savers/investors. After the investor takes a personalized questionnaire and funds the account, Betterment invests the assets to achieve the greatest return for the least amount of risk. The management fees are low, and the portfolio is constructed to minimize taxes.
Discount Brokers Join the Ranks
Traditional discount brokerage houses, such as Schwab, Fidelity and Vanguard, have also joined the robo-advisor fray with robust offerings and competitive terms and fees. By offering lower fees and lower asset minimums, such services dovetail into their traditional financial advisory and asset management businesses.
How Do They Differ from a Human?
Many investors want the opportunity to pick up the phone or walk into the office of the individual or firm handling their money. The traditional advisor offers that option – at a price. Generally, advisors either earn money on commissions for products they sell, based on services provided or based on via a flat percentage fee based on assets under management. Generally, greater levels of assets mean lower management fees and higher-touch services. The fees charged by traditional advisors will be higher than those charged by technology-assisted investment advisors.
What About Returns?
Which type of advisor offers the likelihood of the greatest returns?
This is a more difficult question to unpack. Investment returns depend upon asset allocation, period, types of securities and market conditions. Abundant research supports an index fund investing approach for market matching returns. Many robo-advisors champion the index fund investing approach. But, traditional advisors also incorporate index fund investing for their clients as well. (For related reading, see: The Lowdown on Index Funds.)
Currently, it’s difficult to compare technology advisors returns with those of traditional planners categorically. There are too many factors, and diverse scenarios make this type of comparison challenging.
What's the Best Robo-Advisor for Me?
The decision of whether to go with a traditional or newer variety robo-advisor is a personal one. If you want the personal touch and trust the skills and competencies of the financial advisor, you may prefer the traditional variety of financial help. (For related reading, see: Advice for Finding the Best Advisor.)
If you are a techie or do-it-yourselfer who wants a bit of assistance, the robo-advisor may be for you.
On the other hand, if you want a combination of both, there are traditional financial advisors who use a technology assisted platform. For example, Jemstep is partnering with many traditional investment advisors, and Charles Schwab offers its Institutional Intelligent Portfolios (advisor-focused) along with its investor-focused Intelligent Portfolios. And Betterment has partnered with Fidelity Investments. Several technology assisted platforms also offer access to financial advisors. With all this cross-pollination, the lines of both types of advisors are blurred between service models, fee structures, and investment options. (For related reading, see: Why the Best Financial Advisor Might Be You.)
The Bottom Line
Each of these platforms offers a different approach for the investor. The investor must understand that most investment recommendations are based upon historical data inputs. In other words, both the technology algorithm and human investment advisors look at the past to project future financial asset performance. No financial advising system is perfect, and there is no assurance that past performance is an accurate predictor of the future. Many of the recently launched investing tools were created during an enduring bull market. When markets turn south, as they periodically do, it will be interesting to see how an automated approach works out. As with all financial decisions, consult your trusted advisors, do your research and decide which financial solutions are right for you. (For related reading, see: How Financial Advisors Can Adjust to Robo-advisors.)