The overriding idea behind robo-advisors is that the company's proprietary algorithm takes the emotion out of investing and helps the investor achieve better returns for a lower cost than traditional (i.e., human) financial advisors.
Robo-advisors are digital 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.
Here's a look at some advantages and disadvantages of this relatively new and ever-expanding investment management solution.
Key Takeaways
- Robo-advisors are digital investment services aimed at ordinary investors—they are becoming an increasingly popular way to access the markets.
- On the plus side, robo-advisors are low-cost, often have no minimum balance requirements, and tend to follow strategies 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 critical when investment planning.
Pros and Cons of Robo-Advisors
Pros
Lower Fees than Financial Advisors
Robust Investment Models
Easy to Open an Account
May Have Lower Account Minimums
Cons
Limited Personalization
Limited Flexibility
No Human Contact
Can Be More Costly Than Doing it Yourself
Advantages of Robo-Advisors
Lower Fees than Financial 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, and there are many low-cost robo-advisors to choose from. For instance, Charles Schwab's Intelligent Portfolios come without advisory fees or commissions, while the Wealthfront and Betterment models also favor cost-conscious consumers.
Robust Investment Models
Betterment and many robo-advisors' algorithms rely on Nobel Prize-winning investment theory to drive their models. Generally, best practices investment theory strives to create an investment portfolio with the greatest return for the smallest risk. Some of the best robo-advisors use cutting-edge investment portfolio research informed by modern theories to drive their products.
Easy to Open an Account
It's becoming more common for traditional financial planners to "white label" robo-advisors' platforms for their clients. This takes the cumbersome task of choosing assets out of their hands so that financial advisors can 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 a good option for young people who are just starting to work and invest.
Some consumers—like younger investors or those with a lower net worth—may not have considered professional financial advice. However, robo-advisors are growing the existing market of financial advisory clients. Because robo-advisors provide easy access and lower fee models, more consumers may choose this type of professional management in lieu of the do-it-yourself investing model.
May Have Lower Account Minimums
Investors with a small net worth can get professional financial management through a robo-advisory service. With 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.
An advisor such as Rebalance360 has a higher barrier to entry, with a minimum entry fee of $500,000. 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 are rock-bottom fees, there are several robo-advisors with broadly diversified low-fee exchange traded fund (ETF) portfolios. Some robo-advisors also 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
Limited Personalization
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. You may benefit from talking to a human being who can help tailor your investment plan to your specific situation.
Limited Flexibility
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 even some newer investors may want a broader investment portfolio with a wider range of asset classes than the typical robo-advisor offers.
No Human Contact
If you want a relationship with your financial advisor, then most robo-advisors aren't for you. Robo-advisors 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 robo-advisors will not hold your hand and comfort you after a significant market drop. In contrast, a humanfinancial advisor can be available to assuage your fears and explain how the investment markets work. Whereas a financial planner can integrate your finances, taxes, and estate plans, robo-advisors lack this human touch and have no capacity to take a holistic view of your financial life.
Can Be More Costly Than Doing it Yourself
Robo-advisors often charge fees, which will vary depending on your account balance. For example, Betterment charges a monthly fee of $4 for accounts with low balances. This fee automatically switches to 0.25% annually once the account grows to above $20,000 or if there are monthly recurring deposits of $250 or more. Also, note that your money will often be invested in ETFs. Even though these ETFs often have a low expense ratio, this is an additional cost that should be factored into your total cost.
Robo-advisors use algorithms to automate trading. Robo accounts can be accessed through the internet and your devices.
Evaluating Robo-Advisors
When deciding whether to use a robo-advisor or choosing a platform, one critical issue is how an advisor performs compared to its benchmarks. Is the robo-advisor's portfolio outperforming the returns of the broader market or more passive investing strategies like holding index funds and exchange-traded funds (ETFs)?
Of course, the ups and downs of the overall market have an impact on the investments selected by the robo-advisor's algorithm. Over the past three years, robo-advisor returns have mirrored the pandemic downturn and the subsequent recovery. However, for a robo-advisor to prove its worth, it needs to exceed market returns on a consistent basis.
Condor Capital Wealth Management publishes a quarterly assessment of robo-advisory platforms, analyzing their returns over the trailing one-year, three-year, and five-year periods. The Robo Report for the first quarter of 2023 considered 42 accounts at 27 different robo-advisory providers to see how they stack up. One of Wealthfront's portfolios sits atop the rankings for generating the best returns over the past three years and the past five years, having benefitted from its allocation to energy stocks.
Are Robo-Advisors Safe?
If you're considering a robo-advisor, you may be concerned about trusting your investment decisions to an algorithm. On the surface, robo-advising is just as safe as working with a human financial advisor. A robo-advisor's platform may include biases or errors that prevent it from achieving the best investment returns, but then again, humans are also subject to mistakes. One potential drawback is that robo-advisors are built on data from the past and may be less capable of responding to unanticipated developments in the markets.
Are Robo-Advisors a Good Investment?
Like any type of investment, determining whether a robo-advisor is right for you depends on your goals and preferences. Given their low cost and low minimums to get started, robo-advisors could represent an attractive option for people who are newer to investing or have smaller amounts to invest. However, robo-advisors offer limited flexibility to customize your investment strategy, and they can't provide more integral financial advice that accounts for things like tax and estate planning.
Which Is the Best Robo-Advisor?
When determining the best robo-advisor to meet your investing needs, there are several key factors to consider. In addition to fees and potential minimum investments, you will likely want to look for a user-friendly platform with solid tools to help you construct and manage your portfolio. You can also think about other issues that may be important to you, like socially responsible investing or mobile functionality.
The Bottom Line
The robo-advisory sphere is changing the game by lowering fees while allowing more investors to benefit from 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.
