What Robo-Advisors Can and Can't Do for Investors

Robo-advisors can invest and perform basic money management functions for consumers today at a fraction of most human advisors' costs. But for all they can do, robo-advisors have their limitations—there are still many functions that only a human can do.

Here's a breakdown of what robo-advisors can and can't do for you at this point in their development.

What Robo-Advisors Can Do

When it comes to making logical financial decisions and performing routine money management chores, robo-advisors are excellent tools to help you stay on track and maintain your initial portfolio allocation over time.

Reduce the Costs of Frequent Transactions

Most robo-advisors are designed to follow Modern Portfolio Theory, balancing risk with reward. One of their greatest advantages is that they can perform all of these functions at a very economical cost. Most programs only charge a fraction of a percent for their services and, in some cases, are even free—depending on the amount you put into your account.

Autorebalance Your Portfolio

They can easily perform dollar-cost averaging, portfolio rebalancing, and harvesting tax losses. The program will sell losing holdings to offset the capital gains generated from selling appreciated positions.

This algorithmic trading has been around for more than a decade, but it didn't enter the mainstream market until after 2008 when platforms such as Betterment and WealthFront entered the arena. These robo-advisors allow even novice investors to create a portfolio based on their risk tolerance, time horizon, and investment objectives. You only need to answer a few questions posed by the program that tells it what you want it to do with your money.

Keep You Updated On Your Investing Activity

Once they have this information, the robo-advisor will select a group of investments matching this information. You can then monitor the portfolio at any time by logging in to your account.

What Robo-Advisors Can't Do

Robo-advisors do present some limitations despite their technological sophistication. Of course, the most critical element that they lack is human interaction, and there is no substitute for this in some cases.

Understand Your Concerns

A robo-advisor can create a portfolio based on your input into the program. But what if you sustain a loss and decide to change the entire portfolio based on that single event? This is where a human advisor can work with you to overcome your fear of loss; stay the course with your current portfolio, and not go off track in your long-term investment plan.

Provide Advice

And although they can create personalized portfolios, robo-advisors cannot necessarily provide customized advice based on your preferences or life situation if you can't input those factors into the service. Many of these programs may not be able to screen out certain types of investments that go against a client's beliefs, such as alcohol, tobacco, or fossil fuel stocks. However, many brokerages are changing their robo-advisors to include socially responsible investing options.

Robo-advisors cannot tell if you're unsure of what you want or whether you're unable to answer the questions it poses. They don't have the skills to talk to you about the features or benefits of a product or service or about a poor decision you could be making.

Robo-advisors can only make generalized decisions regarding portfolio allocation. They cannot dispense tax or legal advice and won't keep their clients updated on the latest tax information or estate planning strategies.

Create Complex Financial Plans

Robo-advisors lack the ability to do complex financial planning that brings together your estate, tax, and retirement goals; nor do they take into account your insurance, general budgeting, and savings needs.

While there are computer programs that can provide financial planning, they generally still require data entry from a professional who understands how to input the numbers so that the program can make the necessary calculations to produce an accurate plan.

What It Means for Investors

Robo-advisors will continue to grow more sophisticated as time goes on, but there are some aspects of financial planning that only humans can do. If you're fairly knowledgeable about investments and know exactly what you need to do, you can use these automated services with confidence in many cases.

But if you need help determining what your investment objectives should be or need more personalized advice for your broader financial plans, it might be best to use a human advisor until you become more comfortable.