Categories
Learn

Why a Robo-Advisor | The Pros and Cons

Disclosure: Please note that this article may contain affiliate links

If you have made it here you are probably considering letting a robot help with your investments.

A robo advisor, however, is not for everyone.

Let’s look at the pros and cons of investing with a robo advisor to help you decide if this is really the right fit for you. 

Pros of Using a Robo-Advisor

1. Low Fees

Let’s get the most obvious one out of the way first.

Automation has allowed these companies to manage investments with a lot less personnel than before. Less personnel means less wages to pay and the ability to offer lower fees.

Prior to the introduction of robo-advisors, you were lucky to get financial advice for as low as 1% on your assets under management. In most cases you would actually pay more than that.

Most robos will manage your portfolio anywhere below 0.5%. Some of the services will go as far as to not charging an annual fee at all.

From a cost of zero for M1 Finance, RobinHood or Charles Schwab Corp.’s Intelligent Portfolios to 0.25% for low other low cost providers such as Betterment or Wealthfront, the fees for robos vary however they are usually well below the ones of a human financial planner.

A difference of say 0.5% in management fees may not seem like much but over the years this will accumulate. Just think about compound interest, only in the opposite direction.

The following example showcases this perfectly:


Portfolio Value From Investing $100,000 Over 20 Years

Let’s suppose an annual return of 4%.

A 0.25% fee will result in a portfolio value of $208,815

A 1% fee will result in a  portfolio value of $180,611

So after 20 years the difference between a low cost robo advisor (0.25%) and a low cost personal financial planner (1%) will have amounted to $28,204.

After 30 years, the difference will be $59,021.

After 40 years, the difference will be $109,834.


Yes thats right. If you are in your 30s or even 40s right now, by the time you die you will have spent over $100,000 on a financial advisor.

Now let’s do another fun comparison.

A lot of people have complained about the high cost that Betterment charges for their advice packages: $299 per hour for the highest tier of advice to be exact.

If you save $28,204 over the next 20 years by avoiding a personal financial planner, that would buy you 94.33 hours (which is nearly 4 days of uninterrupted advice) of advice from a Betterment CFP.

Maybe Betterments CFPs are not that costly after all.

2. No human error

Robo advisors use modern portfolio theory as the basis of their decision making. We could go into MPT in great detail however let´s just remember the essence for the sake of the length of this article:

MPT is all about diversifying your asset allocation. It’s about making sure that your investment are allocated in different markets.

Betterment and many of the robo-advisor’s algorithms rely on MPT.

It shouldn’t come as a surprise that robos invest with the intention to get the greatest return for the lowest risk.

Although most robos don’t intend to beat the market, which in all fairness some human financial advisors intend to do, studies have shown that less emotional approach will yield higher returns in the long run.

3. Human financial advisors use robots themselves

Yep. Traditional financial planners actually use robo advisor services for their clients. It is not uncommon to for them to white label the services of one of the big players and sell their services under their own name. (At a higher fee of course)

Don’t believe me?

Just do a quick Google Search of “B2B robo advisor” and you will notice that it is a thriving new trend in the service sector.

Of course the traditional financial advisors derive the same benefits from robo advisors than you. No manual rebalancing or tax loss harvesting, of course they will not pay the same fee that you pay either.

But before I throw traditional human advisors under the rug, let’s also keep in mind that the time they save may be spent on servicing their clients by helping them with tax, real estate, or business issues.

4. Ease of Access

The times when you needed a substantial amount of money to even be considered for financial advice are over.

Especially young investors or beginners in general now have the chance to see their money grow with the help of a robo advisor. The market is growing and the easy to use platforms that sometimes don’t even require a minimum account limit have conquered not only the experienced, but also the younger market segment.

Opening an account is pretty easy, and you don’t have to schedule an appointment to do so.

5. A lot of variety

In the early 2010s there were only a few robos to choose from. Nowadays there is literally a robo-advisor for ever type of client.

From M1 Finance, which allows more of a DIY investing approach to Betterment or Wealthfront which make investing incredibly easy, to a company like Motif which let you invest in theme-based ETFs.

Then there are the ones for a high profile investors. Companies like Rebalance IRA and Personal Capital have higher barriers of entry, but also more access to financial professionals who will guide you through the more difficult decisions.

If rebalancing and tax-loss harvesting is your primary reason to work with a robo, then there are several to choose from as well.

6. Low Minimum Balances

As mentioned earlier, now even investors with a small net worth get professional advisory management. While M1 Finance (one of our favorites) has a very low minimum account limit of $100, the number of robos which allow a minimum balance of as low as 1$ are also increasing by the day.

Folio Investing and Wise Banyan come to mind, and even some of the big players like Betterment have no required minimum balance either.

Then you have the ones like Vanguard with the higher-balance tiers but they also allow for more dedicated human advice.

7. It saves time

A pretty  good reason that is not mentioned very often is that it will save you a lot of time. Especially if you are busy with work, hobbies or just everyday things like kids. Or you may simply have no interest to create that ideal investment portfolio. Or, maybe you have a mix of investments, without any overarching investing plan.

So you can either schedule a meeting with your personal traditional advisor or you could simply change up your portfolio with a couple of clicks within an instant.

Cons of Using a Robo-Advisor

1. Customization

When it comes to customization a traditional human advisor will be able to offer you more options. The more complex your investments the more you will probably need some human advice as well.

Unfortunately, the robos aren’t 100% personalized even though a lot of companies make a pretty good attempt at it. Of course you can edit your goals within the robo advisors platform but when it comes to the intricacies a human will be able to give you expert advice.

There still remain a lot of the money-related issues which benefit from a chat with a human such as real estate, business planning, family and kids etc. The advisor’s office may have a diverse pool of other advisors to help with many aspects of life beyond just “money” concerns.

Also, if you’re in need of someone to explain how the investment markets works, a financial planner is usually the way to go.

Another downside are the actual investments. This really depends on the particular robo however if you want to buy individual stocks or sell call options, most won’t be able to perform that task.

That is only one of the many investment strategies that go beyond the capabilities of a robo. Very sophisticated, professional investors may be better off with a human planner that allows them manage wider range of assets.

2. Not all of them have very low fees

Let’s be clear the majority do have lower fees, just please don’t be fooled into thinking that this goes for all the services out there.

There are the ones who charge almost all the way up to 1%. Personal Capital for example, in some cases charges up to 0.89%.

Just keep in mind that in rare cases the fees can actually get close to the ones of a traditional financial advisor.

Then there are other advisors who will charge an hourly rate, or a fee for service. This is something not all robo advisors offer. This option gives you a chance to control costs when receiving personalized information.

The alternative here are web-based human advisors that are also cheaper than traditional advisors and can help you cut other fees and charges.

3. They are not really the only alternative to a traditional financial planner.

Even if you don’t have sufficient funds there are a couple of alternatives out there.

The XY Planning Network for example, is a fee-only financial planning hub of advisors. They charge monthly at an affordable price.

As previously mentioned, fee-for-service advisors are also a great alternative, especially for those who to trade very infrequently. Being the only alternative to a human advisor is more of a claim that many robo advisors companies make to improve their marketing.

4. No Face-to-Face Meetings

If you’re one to prefer a relationship with your financial advisor, then a robo-advisor is a deal breaker. Even though access to human advisors is possible, you will not have a dedicated advisor initially. If your investment passes a certain amount however then you will.

Meeting in person still won’t be in the cards for you this type of personal contact is still only part of the traditional financial advisory models.

Conclusion

Robo-advisors are here to stay. In fact, the robo-advisory wave is just getting started: There are more services to chose from and competition will only bring the already low fees even lower.

And even if you enjoy investing and are an expert on the subject, you might want to consider making the switch to one the robos.

Just don’t forget that there are not many options for investor flexibility, something that will hopefully change in the future.

As with any life choice, you should figure out what type of guidance you need and select a robo-or human advisor accordingly.

Robo Chooser

Use the following Quiz and find out which robo advisor is best for you.

 

Leave a Reply

Your email address will not be published. Required fields are marked *