Automated investment management services, or robo-advisors, are almost a match made in heaven for retirement accounts, especially for buy-and-hold investors in early or mid-career. Those approaching drawdown age may be better served by a traditional financial advisor, however, when investment strategies tilt toward income generation and tax efficiency,here’s what you should know before you roll your retirement assets into a robo-advisor account.
Robo-advisors are investment management platforms that use complex algorithmic calculations to develop a series of pre-set portfolios based on risk tolerance and investment objectives. They almost always invest in low-cost, tax efficient ETFs, although some trade in other asset classes.
The process for investors is simple: Answer a few questions, supply some personal information, and set up recurring deposits to fund your account. The robo-advisor does the rest, presenting you with a recommended portfolio, and managing all the transactions on your behalf, including often overlooked ones like regular rebalancing and tax-loss harvesting.
Unsurprisingly, it’s these automated extra services that make robo-advisors so valuable and cost effective for retirement accounts. Research shows that portfolios that are frequently rebalanced to the correct asset allocation formula outperform those than aren’t. And although tax-loss harvesting is not an issue in tax-deferred retirement accounts, if you hold any money in taxable accounts, these tax-loss transactions boost your returns. Rebalancing and tax-loss harvesting are provided as part of the account management fee, and transaction fees associated with these services are usually waived with robo-advisors.
Most robo-advisors offer traditional, Roth, and SEP IRA account types; you can open a new account or roll over funds from an existing account into a robo-advisor IRA. If you have an inactive 401(k) account with a former employer, you can also transfer those funds into an IRA with a robo-advisor.
Most robo-advisors will recommend a portfolio based on your income, existing assets, and years to retirement. As you get closer to your target date, asset allocation and fund recommendations are adjusted to minimize risk, maximize returns, and protect your existing wealth.
Robo-advisor retirement portfolios are in many ways superior to the target-date funds, or TDFs, that dominate the retirement account landscape. TDFs are usually offered in five-year increments, such as retirement in 2045 or 2050, while robo-advisor portfolios are focused on a specific retirement date. TDFs also stick to a strict asset allocation schedule regardless of how much you have saved. Robo-advisors continually recalculate your portfolio recommendations based on how much you have saved and how your investments have performed.
Finally, TDFs make the same asset allocations regardless of which types of accounts you own, traditional or Roth, which can have huge income tax consequences when you withdraw your funds. Most robo-advisors use a tax-coordination strategy to optimize the asset allocation in each of the different retirement accounts to minimize tax drag and maximize after tax gains.
It’s important to again point out that not all robo-advisors offer the personalized guidance for income generation and drawdown most retirees require to maximize the funds in their retirement accounts. If you are approaching retirement, you may want to choose a hybrid robo-advisor that offers some level of professional advice from a human advisor or pay an advisor on the side to go over your retirement assets and offer targeted recommendations a few years before you’re ready to retire.
If you have an active employer-sponsored 401(k) account, your robo-advisor options are limited. Although some robo-advisors are breaking into plan administration, few employers have jumped on the robo-advisor bandwagon. Most 401(k) plans don’t allow you to rollover an active account to a robo-advisor while you are still employed.
There is, however, one robo-advisor alternative for employees with active employer 401(k) accounts. Blooom is an investment management service specifically for employees; its only service is managing 401(k) accounts. It works with any employer-sponsored plan as long as it offers online access.
After you link the Blooom platform to your 401(k), it analyzes your current investments to weed out the ones that don’t align with your retirement goals. Then it combs through the available investments options and chooses the least expensive funds that get you closest to your ideal portfolio for your specific situation. Blooom manages your account for you, switching funds in your portfolio as needed, and regularly rebalancing your assets. Blooom charges $10 a month for this service, so if you have at least $50,000 in your account, the fees are comparable to or less than the fees for most robo-advisors.