Investing: Should You Use a Roboadvisor?

Ever wish you could get started with investing, but you felt like you needed a financial advisor to help you figure it all out?

Thanks to technology, people are turning less to human advisors and relying more on roboadvisors. In order to understand how roboadvisors fit into the picture, it’s important to look at the history of investment advice and management.

INVESTMENT ADVICE AND MANAGEMENT: THEN

Investing used to revolve around the relationship between individual brokers and investors. Brokers would buy and sell on their client’s behalf because the average person could not easily access these investment products on their own. As such, brokers usually charged based on commission. A broker that is paid straight commission could potentially recommend trades that would benefit them more than it would benefit their client. Unfortunately, there was little the investor could do to work around this system.

INVESTMENT ADVICE AND MANAGEMENT: NOW

People can now set up and direct their own investments through online brokerage firms (such as Vanguard, Charles Schwab, and Fidelity). This setup has basically eliminated the individual broker that used to act as the middleman between the investor and their investments. As a result, anyone can become a DIY investor.

However, many people are not comfortable going at it alone, so they seek out financial advisors when it comes to investment advice. This makes sense, since many people who want general financial advice also want specific advice about how to pick and manage their investments. In fact, this may be the primary reason that clients seek out a financial advisor in the first place.

Financial advisors are typically compensated through an assets under management (AUM) model, where they are paid a percentage (typically around 1%) of your assets as compensation for investment advice and management. For example, if you have $100,000 in assets, then they would take $1,000 out of your account as their annual compensation for their services.

Financial advisors are changing their business models and are becoming more and more available to people across all income levels and life stages by moving away from the AUM fee structure. They are bundling in financial planning in addition to investment advice, which would include areas like budgeting/cash flow, insurance, taxes, and estate planning. You can read more about financial advisors here.

But let’s face it, we’re in the digital age, and people want the ability to do almost anything from the comfort of their laptop while still in their pajamas. This includes investment advice and help managing their investments. So if you’re somewhere between a DIY investor and someone who wants to work with a full-service financial advisor, then a roboadvisor may be the answer for you.

WHAT IS A ROBOADVISOR?

Simply put, a roboadvisor is a service that uses computer algorithms to pick and manage your investments. The two best known roboadvisors are Betterment and Wealthfront. The number of roboadvising companies and services is rapidly growing and continually evolving in order to meet the needs of beginner investors.

As with any service, especially one that is growing so quickly, it will do you well to take some time and research your options before making a commitment. Here are some factors that you need to take into account when making your decision.

AUTOMATION

As I mentioned in this post, automation is beautiful. It leaves you time and mental space to do other things in your life that bring you more joy. Roboadvisors automate your investing by:

• Building an investment portfolio based on your time horizon and risk tolerance. This all starts with a simple questionnaire.
• Managing your portfolio through rebalancing, which means that it will adjust your asset allocation over time to fit your investing goals. You can read more about asset allocation here.
• Tax-loss harvesting in order to offset losses for a tax benefit. Who doesn’t like a tax win?

If you have a good grasp of how investing works as a part of your overall financial plan, then you will appreciate the automation that is provided through roboadvisors.

However, there is a downside to automation. When you use the “set it and forget it” method without regularly checking in, then you could end up with results that don’t reflect your money and life goals, which will inevitably change over time. Investing as a young, single new graduate versus investing as a mid-career veterinarian who is married with dependents will look different.

No matter what you choose to automate in your day-to-day life, whether it’s your personal financial system, ordering through Amazon Prime, or buying your groceries through a delivery service, you still need to evaluate your automation system on a regular basis and change it if it no longer fits your current lifestyle and personal goals.

Some roboadvisors offer a hybrid service where you also have access to a human financial advisor. You will be expected to have a higher minimum to qualify for this service, and/or it will require a higher fee.

LOWER ACCOUNT MINIMUMS

The minimum amounts to get started will vary, but they are generally MUCH lower than what you would need with a traditional financial advisor. Some roboadvisors even have a $0 minimum. No longer can someone use the excuse of not having enough money to invest.

Many human advisors working with an AUM fee structure require a high minimum in order to work with them. The minimums can easily be in the six-figure range. This had previously been a big barrier to getting started with investing, and more and more people are questioning why those with substantial assets should have the privilege of getting investment advice while those with negative or little assets (such as a new grad with six figure debt!) are left to figure this out on their own. The financial industry is finally taking notice that young people need good, solid investing advice, too.

FEES

Roboadvisors have fees that typically follow the AUM fee structure. However, rather than the typical 1% charged by human financial advisors, the fees will range from 0-0.89%. If a roboadvisor is charging a 0.25% fee, then you will be charged $250 for a $100,000 portfolio. Compare this to a financial advisor, who is charging $1,000 for the same portfolio as mentioned previously. If you’re using a financial advisor, you have to make sure that they are offering you an additional $750 in value for their services.

These percentages may not seem like a lot, but after reading this post, you’ll see how powerfully compound interest can make those small percentages add up to substantial amounts over time. Seeing these numbers is why so many people opt to go the DIY route and manage their own investments.

The lower your assets, then the less fees will impact your bottom line. This is a great incentive for beginner investors, even those with negative net worth, to get started with investing.

RANGE OF INVESTMENT ADVICE AND MANAGEMENT

Although roboadvisors can set up an investment portfolio for you, they can’t necessarily manage ALL of  your investments. Investing doesn’t only refer to your typical brokerage/taxable account. Remember that you are also investing when you have a workplace retirement plan, such as a 401(k). Some services will help you manage your 401(k) (this is Blooom’s speciality) while others will not.

Don’t forget about owning bonds, CD’s, IRA’s, and college savings plans, such as 529 plans. You may have real estate or business investments. The more investments you have, the less likely a roboadvisor can manage your entire investment portfolio.

NEW KID ON THE BLOCK

The field of roboadvising is relatively new. In fact, Betterment is the “grandfather” of roboadvisors, and it has only been around since 2008. As of this writing, we’re in the longest running bull market in American history. At some point, the market will go through a downturn as a part of the typical cyclical nature of the stock market (read this for more stock market history, as well as why you shouldn’t be afraid of market declines and recessions).

How roboadvisors will fare through the next recession remains to be seen. Will their clients stay the course, despite volatile market conditions? Will their portfolio strategies hold up? Only time will tell.

DIFFERENT FUNDS AND STRATEGIES

Although these roboadvisors follow the same general investment philosophy of using index funds/ETF’s and passive investing, each company will still have its own investment strategy/style and offerings of funds in their portfolios. The Charles Schwab Intelligent Portfolio is known for incoporating a lot of cash as a part of their portfolios, Acorns focuses on micro-investing, and Ellevest caters to a female audience. You will need to find a roboadvisor that fits your specific needs and matches your personality.

INVESTING IS A PIECE OF YOUR OVERALL FINANCIAL PUZZLE

Your financial situation is like a puzzle with many moving parts. Your investments are just one portion. If your investments don’t match up with the other parts of your plan, then you’re not optimizing your finances. Remember, you’re working really hard for your money, and you want to make sure that your money is working hard for you, too. You want to be certain that by focusing on investing, you’re not losing sight of your whole financial picture.

CONCLUSION

When looking at all of these factors, it’s clear that even if you want to outsource your investment management in order to stay relatively hands-off with your investments, you will still need to put in some time and effort into choosing the best roboadvisor for YOU.

In short, a roboadvisor is a good fit if:

• You’re young with a long time horizon ahead of you
• You don’t have much in assets and you just need to get started
• You’re only looking for investment management, not comprehensive financial planning
• You don’t have much interest in being a DIY investor
• You don’t mind paying the extra fees for this service
• You understand the importance of investing during market downturns and you’re confident that you will stay the course with your investment plan.

On the flip side, roboadvisors may not make sense if:

• You are nearing retirement
• You have substantial assets
• You need more comprehensive financial planning
• You want to be more hands-on with your investments
• You don’t want to pay extra roboadvising fees

Roboadvisors are filling a much needed space and can certainly simplify your financial life. To be clear, you still need to be in the driver’s seat and understand how roboadvisors fit into your overall financial plan.

Investing doesn’t have to be difficult; in fact, it’s often said that boring is better when it comes to investing. So don’t discount the fact that you can absolutely learn to DIY your investing if you choose to go that route over using a roboadvisor. Check out the book recommendations and blog posts devoted to investing.

Ask yourself: “What are my investment goals? Will a roboadvisor be better at helping me achieve these goals compared to investing on my own or through a financial advisor?” By keeping the end in mind, you can feel more confident about whether roboadvisors are right for you.

Are you thinking about using a roboadvisor? Or are you already using one? If so, what are your thoughts? Comment below!