Robo-Advisors and Young Investors

Robo-advisors have been on the scene for a few years now, thanks to pioneering companies like Wealthfront and Betterment. While they market themselves as enabling the democratization of investing and giving access to beginning investors and small investors, it happened that many small investors and beginners are also young investors, and young investors are digitally native, so they love the applications of these robo-advisors. It's no surprise, then, that these companies are targeting the millennial generation and looking to give younger investors opportunities that they may not have had in the past.

Key Takeaways

  • Robo-advisors are automated investment platforms that offer very low fees and low starting balances.
  • As a result, these services are attractive for beginning investors, specifically younger investors who are just getting started.
  • If you're new to investing, check out both robo-advisor offerings and what traditional advisors can bring to the table. Weigh the costs and benefits before making your choice.

Investing Before Robo-Advisors

Until recently, you basically only had just two options for investing—do it yourself or hire a financial advisor.

The former can be overwhelming for a young investor, and even seasoned investors make mistakes and fall victim to emotions. The second option, on the other hand, can lead to hefty fees the young investor might not be able to afford—and there's no guarantee that your advisor will do a great job. As such, robo-advisors seem to be bridging the gap and making it easier for people to invest. Indeed, robo-advisors automate trading decisions without any human emotion and offer very low fees and often no minimum balances to get started.

Since robo-advisors have come into the picture, young investors, some financial advisors, and even large companies like Vanguard and Fidelity have jumped on the trend. However, robo-advisors are certainly not without their critics. Their mere existence has brought up questions about whether or not a machine can invest better than a human at a lower cost.

How Robo-Advisors Work

Regardless of where you may stand in the robo-advisor debate, one thing is absolutely certain: Robo-advisors do have some benefits, especially for young investors.

First and foremost, they are easy to use and most of their user interfaces are rather intuitive. With Betterment, for example, you can have your retirement goals and contributions set up within minutes. The process of transferring your retirement from another institution into Betterment is also very simple. Further, the use of automation also ensures that you are making contributions without having to even think about it. In many ways, you can simply set it and forget it.

Another reason robo-advisors are very attractive to young investors is because people can invest whatever they have. Got an extra $20 left over this month? You can easily deposit this into your account and invest it. Whereas, formerly, the cost of entry for funds was usually out of reach for young investors. Some robo-advisors require a minimum of $1,000, $5,000, or more—but several also have a $100, $5, or even $1 minimum, making those robo-advisors super accessible.

Perhaps a robo-advisor's most compelling aspect is lower fees. They also offer free trades and no transaction fees. If you were doing it yourself, these two things alone could cost you thousands. They do charge an annual management fee based on assets held, usually around 0.25% per year. Compare that to 1% or more charged by human advisors.

Some robo-advisors also offer services like tax-loss harvesting and portfolio rebalancing automatically. These are services that were formally reserved for the clients of elite financial advisors, and yet robo-advisors have done their part in democratizing them.

Some financial planners agree that robo-advisors have some major advantages. "It doesn't take that much effort," says Katie Brewer, certified financial planner and president of Your Richest Life, a financial planning firm that specializes in working with Gen X and Gen Y investors. "Your portfolio is usually allocated into different asset classes for you and they do regular rebalancing," adds Brewer. While establishing an ideal portfolio may not be hours of work, keeping it and maintaining it at its target weights and automatically rebalancing would require hours of monitoring and trading.

Why They May Not Work for Everybody

No matter which way you try to slice it, a machine cannot fully replace a human. Yes, machines can help lower costs and make the barrier of entry much easier to attain for young investors, but can young investors really get a return on their investment?

On the one hand, this remains to be seen. Robo-advisors are still pretty new in comparison to traditional methods of investing. The fact of the matter is we may have to wait and see in order to really answer this question. In fact, since robo-advisors got started in the 2010s, there has been a secular bull market and we don't know how they'll perform if things turn negative.

Some analysts have begun comparing the portfolios a robo-advisor would suggest versus that of a financial advisor. In 2015, MarketWatch compared the portfolio recommendations of some of the top robo-advisors and compared them to the asset allocation of a human financial advisor. The results were shockingly different, even among some of the robo-advisors themselves. For example, the Charles Schwab robo-advisor was the only one that recommended that a 35-year-old with $40,000 to invest should buy some gold and keep 8.5% of the portfolio in cash. This is in stark contrast to more common investing advice. This would suggest that young investors should do more research before choosing a robo-advisor.

Additionally, there may some costs investors weren't expecting. "If you have non-retirement accounts open and have your investments on autopilot, you could be paying taxes for investments that were sold throughout the year," warns Brewer. Brewer also adds that some portfolios may not be customized, which could be a problem if you own a lot of company stock or RSUs.

The Hybrid Option

The same MarketWatch experiment also found an interesting trend. Some young investors are actually participating in a bit of a hybrid between using a robo-advisor and hiring a financial advisor.

In fact, several financial advisors who work with millennials are not against robo-advisors at all and use them as a part of their services. One such advisor is Sophia Bera of Gen Y Planning, who uses Betterment to handle the tax-loss harvesting and asset rebalancing for her clients so she can focus on other aspects of financial planning for them.

Financial Advisors for Young Investors

It wouldn't be fair to talk about young investors without mentioning that there are now networks of financial advisors who are dedicated to working with them.

A common complaint in the past was that financial advisors would not work with younger investors because they didn't have enough assets. Likewise, young investors found financial advisors too expensive.

Movements like XYPlanning Network have helped bridge this gap by creating a database of fee-only advisors who will work with Gen X and Gen Y investors. They are typically much more accessible to younger investors and as previously mentioned, they like to use technology to make things easier for themselves and their clients.

The Bottom Line

One thing is certain, young investors have more options than ever before when it comes to saving for retirement and building their own portfolios. While robo-advisors can certainly be a good option, young investors shouldn't be completely opposed to hiring a financial advisor.