Is a Robo-Advisor Right for You?

Online financial advisors, known as robo-advisors, can be found at many financial institutions such as Fidelity Institutional, Charles Schwab Corp., and others. In fact, nearly every financial company either has its own robo-advisor or is in partnership with one.

Is a robo-advisor right for you? The answer, like most questions in the financial planning world, is "it depends." Here are a few thoughts to consider.

What Level of Advice Do You Need?

The first thing you need to think about is what level of advice and expertise you need to manage your money? If you have a seven-figure portfolio and need guidance 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. 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 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 or autonomy in making investment choices, you may want to look instead to self-directed online trading platforms like Robinhood, E*Trade, or TD Ameritrade—all of which now offer free trading in most stocks and ETFs.

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 in the robo-advisor space.

For example, Personal Capital, which considers itself a "digital asset management service" and not a robo-advisor, offers online services geared a bit more up-market and targets investors with portfolios ranging from $100,000 and 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.

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 a financial advisor.

Understanding What's Behind the Advice

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

Most 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 generate the highest expected return for a particular amount of risk.

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. We have been seeing some of this for several years with features like online client portals on the websites of many financial advisors.

In the future, we may see some variation of an online advisor offering by more traditional financial advisors to attract younger clients. The idea behind it may be that these young investors will grow into more prominent 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 eliminating a physical presence and conceivably the opportunity to reach a broader range of potential clients.

What Happens During Market Volatility?

When a market is volatile, it can be worrisome to some investors. As a result, they react differently, from calling their financial advisor to changing their portfolios to leaving everything alone.

Robo-advisors, which do well as long-term investing tools, allow investors to choose portfolios based on a set of personalized financial goals, and the portfolios are rebalanced by investment professionals via the robo-advisor. When markets get volatile, emotions may run high. However, a robo-advisor makes disciplined decisions that are not emotionally driven.

For example, during market volatility in 2020, robo-advisors held up in the face of a stressed market. According to research from financial advisors at Backend Benchmark, "many robo advisors with unique strategies or holdings performed better in terms of performance above/below the Normalized Benchmark."

For some, a personal advisor who can talk to you about the market and your options may be a better bet for some nervous investors who need a more customized approach to their portfolios. However, robo-advisors are poised to perform well during market volatility, but investors who need personalized one-on-one service may feel better with a human advisor.

The Bottom Line

All businesses are impacted by the advancement of technology and by changes in general, and the financial services industry is no exception. And financial advisors are very reliant on technology for so much of what they do, so the evolution to online advisors is no surprise.

Is an online advisor right for you? For many, the answer might be "yes," especially for younger, less-affluent investors who may be underserved by the financial services industry.

As robo-advisors continue to evolve within large financial institutions, they will likely continue to offer even better options for investors and savvy financial advisors.