Robo-advisors have been on the scene for a few years thanks to pioneering companies like Wealthfront and Betterment. While they market themselves to beginning investors, let’s be frank and realize that many beginning investors are also young investors.
Thus, these companies are giving young investors opportunities they may not have had otherwise. Up until recently you basically only had two options for investing — do it yourself or hire a financial advisor.
The former can be overwhelming for a young investor. The second can lead to hefty fees the young investor may not be able to afford. As such, robo-advisors proclaim to be bridging the gap and making it easier for people to invest.
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.
Why They Work
Regardless of where you may stand in the robo-advisor debate, one thing is absolutely certain: Robo-advisors do have some benefits 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.
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.
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.
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 financial advisors, and robo-advisors have done their part in democratizing it.
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.
Why They May Not Work
No matter which way you try to slice it, a machine cannot 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.
However, some have taken matters into their own hands by comparing the portfolio a robo-advisor would suggest versus that of a financial advisor. Earlier this year, 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 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, 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.