Is An Online Financial Advisor Right For You?

Online financial advisors, known as robo-advisors, are all the rage right now—at least according to the financial press and what's showing up on social media. There is definitely something to this, as Fidelity Institutional recently struck a deal with online advisor Betterment, while Charles Schwab Corp. (SCHW) recently unveiled its own robo-advisor service. In fact, nearly every financial company either has their own robo-advisor or is in partnership with one.

What is all this hype about—and is a robo-advisor right for you? The answer, like most questions in the financial planning world is that "it depends." Here are a few thoughts to consider.

Key Takeaways

  • Robo-advisors are low-cost automated investment platforms that manage money using algorithmic execution.
  • These platforms are best-suited for new or beginner investors who may not have a lot of money but still want to start contributing to an investment portfolio.
  • With a robo-advisor, you can expect an optimized long-term portfolio, but you will sacrifice being able to make your own investment choices as well as some human touches.

1. What Level of Advice Do You Need?

The first thing you need to think about is what level of advice and expertise do you really need for managing your money? Certainly if you have a seven-figure portfolio and need advice in complex areas like tax planning, estate planning, the exercise of stock options, and the like, then a robo-advisor is probably not for you, at least in their current state. Folks like this are better-served by a relationship with a more traditional financial advisor.

For millennials and others with more modest portfolios who may just need some asset allocation advice and perhaps a bit of basic financial planning help, many of today's online advisors might fit the bill. Robo-advisors for the most part construct portfolios that follow passive strategies like indexing. They are relatively straightforward investment strategies that use ETFs to optimize a portfolio's risk versus expected return. Beginners and those who prefer to just set-it-and-forget-it are most likely to appreciate the automation that robo-advisors bring. Because robo-advisors are low-cost and don't require sizable minimums to open an account, they are appealing to people who would not normally be able to afford a traditional financial advisor.

With a robo-advisor, you won't be able to pick stocks or strategies. Robo-advisors make all the decisions for you. So, if you're the type of person who may not have a ton of money to invest but want more control our autonomy in making investment choices, you may want to look instead to self-directed online trading platforms like Robinhood, E*Trade, or Ameritrade—all of which now offer free trading in most stocks and ETFs.

2. All Robo-Advisors Are Not the Same

Just as all traditional financial advisors are not the same, neither are all online advisors. In the world of traditional financial advisors, there are differences in their areas of expertise, how they are compensated, and the types of clients they work with. The same holds true in the robo-advisor space.

For example, online advisor Learnvest caters to a variety of people with needs, ranging from basic budgeting to those requiring financial planning and investment advice. Their fees range from around $70 to $400 on a one-time basis with monthly charges for ongoing support. And Personal Capital offers services geared a bit more up-market and is targeting investors with portfolios ranging from $250,000 to $1 million on up. On the other hand, Acorns requires just $5 to get started and features tools like rounding-up spare change on purchases to be invested in your portfolio.

Some robo-advisors only allow broad-based index investing, others are increasingly adding socially responsible portfolios for those clients who are conscious of those matters. Others, like M1 Finance, let users customize their portfolios based on themes or popular strategies.

3. Convenience and Accessibility

One of the major pluses of online advisors is the convenience of working with them and the ease of accessing their services. This generation is very used to buying goods and services online, so why not financial advice?

Online advisors are accessible 24/7, which might appeal to a wide range of clients. With everyone's busy schedules, this level of accessibility might be the impetus for some folks to go and get the financial help they need.

At the same time, many robo-advisors are fully automated and only have limited human involvement. While some do have human advisors on staff to field calls and customer questions, most of these advisors are not actually working on your portfolios or investment choices—those are all done by the algorithms. Instead, these human interlocutors are there to keep your emotions in check and act more like a coach or therapist than financial advisor.

4. Understanding What's Behind the Advice

Just because an online advisor is accessible and reasonably priced doesn't mean that the advice is any good. It's incumbent upon anyone looking at using an online advisor to do their homework first and to understand how investment recommendations are generated.

Most of the robo-advisors utilize algorithms of one sort or another in making their investment recommendations. While you might not be a mathematician or an investment expert, at the very least ask questions and read up on their investment methodology to see if it makes sense to you. The majority of robo-advisors follow investment strategies based on modern portfolio theory (MPT) in some form or another, and robo-advisor investment strategies can often be found by searching their website or from FINRA filings. MPT is a method of optimizing indexed portfolios by determining the best mix of asset class weights that generates the highest expected return for a particular amount of risk.

5. Does it Have to Be "Either Or?"

It seems that with the likes of Schwab and Fidelity getting into this space, it won't be too long until some of the best aspects of the online advisors overlap into the service offerings of traditional brick-and-mortar advisors. In fact, we have been seeing some of this for several years with features like online client portals on the websites of many financial advisors.

It's likely that we will see some variation of an online advisor offering by more traditional financial advisors in the future in an effort to attract younger clients who can then grow into the larger clients who need, want, and can afford more traditional full-service advice.

Working with clients online and remotely also has advantages for the traditional financial advisor. While there are certainly costs to build out and maintain their website, there would be savings resulting from the elimination of a physical presence plus conceivably the opportunity to reach a wider range of potential clients.

6. What Happens When the Market Heads Down Again?

The growth of online advisors has occurred during a torrid bull market that has been going since March of 2009. What will happen to these firms during the next bear market? Will their younger, inexperienced clients bail on their investments? It's difficult to say for certain; however, one advantage to the human touch is the opportunity for the advisor to talk nervous clients off of the proverbial ledge.

The Bottom Line

All businesses are impacted by the advancement of technology and by change in general. The financial services business is no exception. In fact, financial advisors are very reliant on technology for so much of what they do. The evolution to online advisors is no surprise. Is an online advisor right for you? For many the answer might be "yes," especially younger, less-affluent investors who have been terribly underserved by the financial services industry. This space will surely evolve over time and offer even better options for investors and savvy financial advisors.