In an era where companies are developing driverless cars and scientists are discovering water on Mars, it’s hard to imagine what the future could bring. But we do know one way the future is already here: robo-advisors.
The software powering robo-advising has been available to professional planners for years; it’s only now that you can skip the middlemen and use the technology directly. But what is a robo-advisor, why are they becoming so popular and how can you use one to aid with your investing? (For more, see: Is a Google Robo-Advisor on the Horizon?)
Machines for the Mundane Tasks
Brandon Marcott, CFP with Edify Financial Planning, likens automated financial services to personal assistants that help with the mundane tasks of day-to-day life; robo-advisors are supposed to take care of the routine duties surrounding basic investing and money management.
“Think of [robo-advisors] almost as personal assistants for your investments,” he said. “While you can schedule your own meetings, respond to emails, take clothes to the dry cleaners, get the oil changed in your car, run errands, etc., you could pay a personal assistant to do all that stuff for you. You pay them a fee, they'll take care of it. That's what a robo-advisor does.”
Robo-advisors are also affordable and accurate, making them a perfect match for people with only a few thousand to invest and years until they hit peak income. That's why they're especially popular among millennials who want to start investing but lack the portfolio minimums that some advisors require; they fill a demand for those who want to grow their assets but can’t afford a planner. As Internet-based software, robo-advisors are increasingly helpful for a generation accustomed to making financial decisions online. (For more, see: A Look at Vanguard's Robo-Advisor.)
Marcott said he’s even found a use for robo-advisors in his financial planning practice.
“Additionally, from an advisor's perspective, if the robo-advisor aligns with your investment philosophy and strategy, they’re a great way to outsource some of the work that you used to have to do manually,” he said. Rather than see robo-advisors as a threat to his business, “you partner with them instead,” said Marcott.
The Pluses and Limits of Robos
CFP Jason Hull is the CTO of MyFinancialAnswers, a robo-advisor based in New Jersey. He said that robo-advisors can invest based on your preferences. If your portfolio becomes too heavily skewed in one area, they can adjust for that.
“A robo-investor is a system that automatically invests your money for you,” he said. “They invest in low-cost ETFs and mutual funds that match your asset allocation requirements, and they frequently rebalance your portfolio so you don't become too heavily weighted in equities or fixed income.”
However, if you're looking for answers to questions about your budget or setting up a trust in your will, you’ll still need traditional financial planning services. Robo-advisors cannot replace talking to a person face-to-face about your husband’s spending habits or your wife’s gambling addiction. They also cannot give you advice on mitigating your tax liability or how to retire in 10 years. They’re often best used in conjunction with a planner who can offer you personal, customized advice.
Although some of us might be wary in trusting a computer program to handle our finances, there are several reputable companies making robo-advisors more useful and more accessible every day. Betterment, FutureAdvisor and Wealthfront are some of the most prominent robo-advisor firms, but there are countless others — some run by well-known banks and brokerage firms — available.
The Bottom Line
Robo-advisors, especially once the market matures, are likely to add a layer of affordable help and insight to most people's portfolio management efforts. Hull notes that they come without the financial bad habits that plague many of us — they won't panic about the stock market and immediately sell funds that have a bad day. They act like the perfect logical investor that most of us aren’t. “They remove the behavioral biases from the equation — usually the No. 1 financial albatross hanging around the neck of the average person,” he said. (For more, see: Robo-Advisors' Next Frontier: 401(k) Plans.)