Pros & Cons of Using a Robo-Advisor
Robo-advisors are shiny new investment platforms. But what are their advantages and disadvantages? Can all digital financial advisors be painted with a broad brush?
Robo-advisors differ from brokerage to brokerage. The catch-all term includes a class of investment managers and software that uses complicated computer algorithms to administer your investment portfolios. Some robo-advisors are completely automated, while others offer access to human assistance as well. Regardless of the model, they all provide customer service to assist you through the process.
The robo-advisor's overriding assertion is that each company's proprietary algorithm claims to take the emotion out of investing and will grant the investor better returns for a lower cost than traditional (that is, human) financial advisors. Yet, each advisor can't have the "best" proprietary algorithm. Let's look under the hood at the pros and cons of using this new and ever-expanding type of investment management.
- Robo-advisors—automated investment services aimed at ordinary investors—are an increasingly popular way to get access to the markets.
- On the plus side, robo-advisors are very low-cost and often have no minimum balance requirements. They also tend to follow optimized indexed strategies that are best suited for most investors.
- On the downside, robo-advisors do not offer many options for investor flexibility, they tend to throw mud in the face of traditional advisory services, and there is a lack of human interaction.
Pros: What's to Like About Robo-Advisors?
1. Low Fees
Prior to the introduction of the robo-advisor platforms, investors were lucky to receive professionally managed investment assistance for less than 1% of assets under management (AUM). The robos have significantly changed that paradigm. From a cost of zero for Charles Schwab Corp.'s Intelligent Portfolios to 0.25% for a Betterment portfolio (after the first free year), there are many low-cost robos to choose from. Wealthfront and Betterment's models favor the cost-conscious consumer.
2. Nobel Prize-Winning Investment Models
Betterment and many of the robo-advisor's algorithms rely on Nobel Prize-winning investment theory to drive their models. As Betterment.com put it in 2013, "When the Nobel committee announced… that Eugene Fama and Robert Shiller would share this year's prize for economics, it was a great moment for their research in the field of investing—and validation for Betterment, which relies on many of their insights."
In general, best practices investment theory strives to create an investment portfolio with the greatest return for the smallest risk. From 1990 Nobel Prize winner Harry Markowitz to 2013 Fama and Shiller winners, the robos use cutting edge investment portfolio research informed by these luminaries to drive their products.
3. Access to Robo-Advisor Services Through a Financial Advisor
It's becoming more common for traditional financial planning practices to "white label" robo-advisors' platforms for their clients. This takes out of their hands the cumbersome task of choosing assets, so that the financial advisor may spend more time with their clients addressing individual tax, estate, and financial planning issues.
In the Dec. 23, 2014, Advisor Perspectives article, "Three Reasons Why Robo-Advisors are a Huge Benefit to the Advisory Profession," Bob Veres cites Betterment, Motif, and Trizic as robos with ready-made portfolios available to the advisors. Jemstep also white labels its platform for advisors. This trend gives the consumer an opportunity for lower-cost investment management while retaining the personal touch of an advisor.
4. Expanding the Market for Financial Advice
Some consumers, younger investors or those with lower net worth, may not have considered professional financial advice. The robo-advisors are growing the existing market of financial advisory clients. Because of the easy access and lower fee models for professional financial management, more consumers may choose robo-advisors' professional management in lieu of the DIY model.
5. Robo-Advisors Aren't One-Size Fits All
There are low-fee robo-advisors for different types of clients. For example, if you're interested in a certain sector or investment theme, then Motif's 151 existing portfolios offer a platform for you. Veres' article mentions that Motif excels at giving their users many idea-based portfolios, from a "shale gas" portfolio to a "fight fat" offering for investors interested in weight loss companies to a caffeine portfolio that culls coffee-related companies for you. If your primary concern is rock-bottom fees, there are several robo-advisors with broadly diversified low-fee ETF portfolios.
Some robo-advisors claim rebalancing and tax-loss harvesting in their arsenal. There are single approach and hybrid-style robo-advisors. Others such as Rebalance IRA and Personal Capital have higher barriers to entry with, respectively, $100,000 to a recently lowered $50,000 minimum entry fees. That said, even the robos with high entry requirements are more accessible than the financial advisors with $1 million portfolio minimums.
6. Low Minimum Balances
It's a boon for investors with a small net worth to get professional robo-advisory management. Zero minimum balance technology-enhanced robo-advisors include Folio Investing and Wise Banyan. Betterment has no minimum balance as well. Other robo-advisors are accessible with $1,000 to $5,000 to get started. And Personal Capital is free for those interested in access to portfolio monitoring, with the higher-balance tiers reserved for exposure to a dedicated financial advisor.
Cons: What's Wrong with Robo-Advisors?
1. They Aren’t 100% Personalized (Yet)
You're more than just an investment portfolio. You have many goals, both for the near and long-term. While many robo-advisors now allow you to set and edit your goals using their financial planning software, you also have money-related issues and concerns which may benefit from a chat with a human being.
Most (although not all) robo-advisors will not hold your hand and talk you off the ledge after a significant market drop. The human financial advisor is there to assuage your fears and explain how the investment markets work. A financial planner works to integrate your finances, taxes, and estate plans. The advisor’s office may have a diverse pool of other advisors to help with many aspects of life beyond just "money" concerns.
If you want to sell call options on an existing portfolio or buy individual stocks, most robo-advisors won't be able to help you. There are sound investment strategies that go beyond an investing algorithm. Sophisticated and newbie investors may want a broader investment portfolio with a wider range of asset classes than the typical robo-advisor offers.
2. They Tend to Bash Advisors' Price Schedules
It's true that most robo-advisors have low price schedules, but not all. It's not true that all financial advisors are expensive. There are financial advisors who charge approximately 1% of assets under management (AUM) for their services. This fee is comparable to those of several robo-advisors.
There are other advisors who will charge an hourly rate, or a fee for service. This practice gives the consumer a chance to control costs while receiving more personalized information. The newer "web-based" personal advisors can forgo the cost of a fancy office and serve you personally via web chat for lower fees. Additionally, there are advisors that "lease" robo-advisors' platforms and combine them with their own advisory services, thereby cutting fees and charges.
3. They Falsely Claim They're the Only Resource for the Little "Guy or Gal"
There are financial-advisor alternatives for those without big bucks or those just starting out. The XY Planning Network is a fee-only financial planning collection of advisors with an affordable monthly fee structure. The XY Planning Network advisors also cater to a younger clientele.
A fee-for-service advisor will put a cap on the client's charges. Trade infrequently with an advisor paid by commission, and your costs can remain low. With the multitude of financial advisors, there are pay models and investment approaches to fit every type of investor.
4. No Face-to-Face Meetings
If you're someone that wants a relationship with your financial advisor, then most robo-advisors aren't for you. The robos don't have an office where a client walks in and talks directly to an advisor. This type of personal contact is relegated to the traditional financial advisory models.
The Bottom Line
The robo-advisory sphere is just getting started. The new entrants into the landscape benefit the consumer by lowering fees while contributing many paths to professional asset management. As with any life choice, the investor should figure out what type of investment guidance he or she needs and select a robo-advisor or financial professional to suit his individual style.