The projections for the growth of robo-advisors are ambitious, to say the least. But just because it's a growing trend doesn't mean it's right for you. It depends on how you like to operate as an investor and what your goals are. So, let's take a closer look at these automated services.
Who Are the Robo-Advisors?
A few of the most popular robo-advisor services today are Wealthfront, Betterment, Personal Capital and FutureAdvisor. These are all independent platforms, though giant investment management firm BlackRock acquired FutureAdvisor in 2015. Several other brick-and-mortar financial institutions have launched robo-advisors to supplement their services. Among them: Charles Schwab, with its Intelligent Portfolios service; Wells Fargo, with its Intuitive investor; and Vanguard, with its Personal Advisor Services.
Wealthfront has a minimum investment of $5,000. If that total is below $10,000, then the service is free. After $10,000, there is just a 0.25% fee. Betterment works a little differently, with no minimum investment required and a 0.35% fee if the total investment is below $10,000. If the investment is between $10,000 and $100,000, there is a 0.25% fee. If the investment is north of $100,000, the fee is 0.15%.
The financial institution-owned robos have similar, if slightly higher, costs; they often give existing clients a discount. Schwab's Intelligent Portfolios charges no fee. It makes money through its proprietary exchange-traded funds (ETFs) and third-party ETFs.
Why Are Robo-Advisors Popular?
A big reason for robo-advisors' popularity is affordability. For instance, 90% of Wealthfront’s 30,000 clients are below the age of 50 and 60% of those clients are below the age of 35. This points to the Millennials, a generation that is still in the early stages of building wealth. Most Millennials can’t afford the fees of a traditional financial advisor, who also typically requires a minimum investment of six figures.
Another reason for the popularity of robo-advisors is tax-loss harvesting, which automatically minimizes tax obligations on your profitable trades and maximizes tax reductions on your losing trades. And, best of all, it’s all done by a computer, requiring zero effort on your part.
What Is the Risk With a Robo-Advisor?
Millennials have seen the worst of it during their lifetimes, including the Dotcom Bubble and 2008 financial crisis. Many are risk adverse and wary of the stock market. Unfortunately, the same pattern that helped create the last crisis is likely taking place again, as the stock market is growing increasingly overheated as of October 2018. Only this time, the problem is global. And instead of just corporations being overextended and unable to pay their debts when growth stalls, entire countries are that list.
Is a bear market is approaching? Even if it isn’t on the horizon, it’s only a matter of time. It’s important to realize that while robo-advisors can rebalance portfolios all they want, those portfolios are going to be almost 100% long (excluding cash positions). It will be impossible for those robo-advisors to deliver a positive return. Investors could well see their assets depreciate, causing robo-advisors to wane in popularity.
Paying for a good financial advisor might be money well-spent in a bear market. Unlike a robot, a human can look at trends, keep up with all the up-to-the-minute headlines and make sense of them in a way that only a human mind can. At least there is the potential of navigating a bear market when you have a human financial advisor. When you use a robo-advisor and the markets head south, your investments are likely to head south as well.
The Bottom Line
Spending money on a top-tier financial advisor that truly understands the economy and markets will be your best bet going forward. If you’re using a robo-advisor, you’re betting on a bull market to keep on running, which is unrealistic. However, if you’re young and willing to wait it out for decades in order to save for retirement, then a robo-advisor can be a viable solution.
At the time this article was written, Dan Moskowitz did not have any positions in Charles Schwab.