Robo-Advisor: An Overview
Robo-advisors are new investment platforms offered by brokerages. This catch-all term includes investment managers and software that use complicated computer algorithms to administer your investment portfolios. Some robo-advisors are entirely automated, while others offer access to human assistance. 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 (i.e., human) financial advisors.
Here's a look at some advantages and disadvantages of this new and ever-expanding investment management solution.
- Robo-advisors are automated investment services aimed at ordinary investors—they are becoming an increasingly popular way to access 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 best suited for new and intermediate investors.
- On the minus side, robo-advisors do not offer many options for flexible investing, and they reduce the human interactions that are sometimes necessary when investment planning.
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Advantages of Robo-Advisors
Before robo-advisor platforms, you were lucky if you received professionally managed investment assistance for less than 1% of assets under management (AUM). Automation has significantly changed that paradigm. From a zero cost for Charles Schwab Corp.’s Intelligent Portfolios to a Betterment portfolio that can include cryptocurrency, there are many low-cost robo-advisors to choose from. The Wealthfront and Betterment models favor the cost-conscious consumer.
Notable Investment Models
Betterment and many robo-advisors' algorithms rely on Nobel Prize-winning investment theory to drive their models. In general, best practices investment theory strives to create an investment portfolio with the greatest return for the smallest risk. Some robo-advisors use cutting-edge investment portfolio research informed by the modern theories to drive their products.
Give Human Advisors Time to Focus on Clients
It’s becoming more common for traditional financial planning practices to “white label” robo-advisors’ platforms for their clients. This takes the cumbersome task of choosing assets out of their hands so that the financial advisor may spend more time with their clients addressing individual tax, estate, and financial planning issues.
Robo-advisors can require as little as $0 to open an account and start investing, making them perfect for a young person just starting to work and invest.
Some consumers, younger investors, or those with lower net worth may not have considered professional financial advice. 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 do-it-yourself model.
Accessibility and Services
It’s a boon for investors with a small net worth to get professional robo-advisory management. Zero and near-zero minimum balance technology-enhanced robo-advisors include Betterment and Folio Investing. Other robo-advisors are accessible with $1,000 to $5,000 to get started.
Advisors such as Rebalance and Personal Capital have higher barriers to entry, with minimum entry fees of $100,000. That said, even the robo-advisors with high entry requirements are more accessible than the financial advisors with $1 million portfolio minimums.
For example, if you’re interested in a specific sector or investment theme, some advisors have hundreds of portfolios to choose from that could fit your needs. On the other hand, if your primary concern is rock-bottom fees, there are several robo-advisors with broadly diversified low-fee exchange-traded fund (ETF) portfolios. Some robo-advisors include services like rebalancing and tax-loss harvesting in their arsenal.
As the technology advances, there will be more services offered by robo-advisors and more choices for investors.
Disadvantages of Robo-Advisors
Not Yet Personalized
Robo-advisors can be configured or programmed to meet the needs of many investors by allowing you to set and edit your goals using their financial planning software. However, they don't consider that you also may have money-related issues and concerns, and may benefit from talking to a human being.
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 broader range of asset classes than the typical robo-advisor offers.
No Face-to-Face Meetings
If you want 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.
Most (although not all) robo-advisors will not hold your hand and comfort you 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.
Robo-advisors are software running on hardware, and you access them through the internet and your devices. This opens opportunities for hackers and thieves to gain access to your accounts.
How an advisor performs compared to its benchmarks are crucial issues when deciding whether to utilize a robo-advisor or choosing one. BackEnd Benchmarking, a leading source of analytics regarding robo-advisors, looked at 20 products in selecting the best robo-advisor for 2021.
Their three-year annualized returns, net of fees (i.e., after expenses), through June 30, 2021, ranged from 7.44% to 12.10%. Their three-year normalized returns vs. their benchmarks ranged from 3.98% below to 0.38% above. Only four of the 20 robo-advisors in the study beat their benchmarks.
The robo-advisory sphere is just getting started. The new entrants benefit you by lowering fees while contributing many paths to professional asset management. As with any life choice, you should determine what type of investment guidance you need and select a robo-advisor or financial professional to suit your style.