Robo-advisors have been on the scene for a few years now, thanks to pioneering companies like Wealthfront and Betterment. One of the key marketing strategies for these digital advisors is to market themselves as democratizing investing and making it more accessible for beginner and smaller net-worth investors.
Not surprisingly, many of these are young investors, and young investors are digitally savvy and love technology. So, it should come as no shock that brokerages and financial firms target Generations X and Y and Millennials.
- Robo-advisors are automated investment platforms that offer very low fees and allow for low starting balances.
- As a result, these services are attractive for beginning investors, specifically younger ones who are getting started.
- If you're new to investing, it helps to compare what robo- and traditional advisors bring to the table. Weigh the costs and benefits before making your choice.
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What Robo-Advisors Do for You
Before 2010, you had two options for executing your investing strategies—do it yourself or hire a financial advisor.
Investors of all experience levels can become overwhelmed, make mistakes. or give in to their emotions during downturns. Traditional financial advisors charge fees many younger or new investors might not be able to afford—and there's no guarantee that your advisor will get you the results you want, either.
Robo-advisors appear to be making it easier for people to invest. They automate trading decisions, eliminate human emotion from the equation, and offer very low fees—often, there are no minimum balances to get started.
Young investors, financial advisors, and even large companies like Vanguard and Fidelity have jumped in on the trend. However, robo-advisors are certainly not without their critics. It's still unclear how well artificial intelligence can execute strategies and maintain a portfolio's value in the long run.
Financial technology is continually under development, with new ideas emerging all the time. Robo-advisors are software that requires updates and maintenance; they also may have new abilities introduced every few months. So if you choose one, make sure you stay up-to-date to get the most from it.
The Benefits of Robo-Advisors
It's becoming clear that robo-advisors have some benefits, especially for younger investors. First and foremost, they are easy to use, and most of their user interfaces (UI) are very intuitive.
For example, Betterment's UI allows you to set up your retirement goals and contributions within minutes—you can even choose from cryptocurrency portfolios. The process of transferring your retirement plan from another institution into Betterment is also straightforward. Further, the use of automation also ensures that you are making contributions. In many ways, you can set it and forget it.
Another reason robo-advisors are attractive is that you can invest whatever you have—got an extra $20 leftover this month? You can easily deposit it into your account and invest it. Previously, the amount required for accessing certain funds was out of reach for certain income levels. Some robo-advisors require low minimum contributions, such as between $1,000 and $5,000—but several have minimums that range between $1 and $100.
Perhaps a robo-advisor's most compelling aspect is the lower fees. Many offer free trades and no transaction fees. These two fees alone could cost you thousands of dollars if you were doing it yourself. However, they tend to charge an annual management fee based on assets held—generally between 0.25% and 0.50% per year. Compared to the 1% or more charged by human advisors, robo-advisors may feel like a bargain.
When you're choosing a robo-advisor, be sure to find out how it avoids conducting wash sales—selling assets for a loss then repurchasing them with similar ones at an even lower cost 30 days before or after the sale.
Some robo-advisors also offer services like tax-loss harvesting and automatic portfolio rebalancing. These services were formally reserved for the high-net-worth clients of elite financial advisors—but robo-advisors have given average investors access to these strategies.
Some financial planners agree that robo-advisors have some significant advantages. Regular rebalancing requires substantial effort on the part of whoever is managing the portfolio. Digital advisors remove the hours of research, monitoring, and trading you might spend on your investments without them.
Other Robo-Advisor Considerations
No matter how hyped-up artificial intelligence is, it cannot fully replace a human. Yes, it can help lower costs and lower the entry barriers for young investors, but can you get a return on your investment? Another question often asked is whether robo-advisors can preserve capital or generate returns during market downturns.
Robo-advisors are still new in comparison to traditional methods of investing. They first appeared in the 2010s, so they have weathered market fluctuations but no deep recessions. Additionally, robo-advisors' ability to combat rising inflation is still being studied.
If you're new to investing, consider talking to an advisor or taking a beginning investor course so that you can understand the jargon and concepts used in the industry. Robo-advisors are generally beginner-friendly, but they still use the financial industry's language and terms.
Backend Benchmarking has released digital advisor reports since 2015. In its third-quarter robo-advisor report, the firm noted that many brokerages had built digital advisor portfolios to protect against inflation. In addition, the report highlighted the fact that the average robo-advisors equity portfolio had annual returns of 12.54% from September 2016 to September 2021.
The data do not indicate future performance, but it does suggest that robo-advisors can be programmed to preserve capital and generate returns during chaotic economic and market circumstances and periods of rising inflation. The caveat in this data is choosing a portfolio through your robo-advisor designed for dealing with these events.
The Hybrid Option
Brokerages have also started to cater to investors who prefer to talk to a human advisor while using a digital advisor. This could be a good choice if you've just started investing and need some advice while managing your finances through technology.
Financial Advisors for Young Investors
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.
Organizations like XYPlanning Network have helped bridge the gap between advisors and young clients by creating a database of fee-only advisors who will work with Gen X, Y, and Millennial investors.
You have more options than ever before when you're planning retirement and building your portfolios. Robo-advisors can undoubtedly be a good option, but you shouldn't be wholly opposed to hiring a financial advisor—especially if you're just getting started.