Robo-advisors are the “next big thing” in financial planning, and consumers are increasingly choosing automated investment management over human financial advisors, at least for a portion of their investable assets. Current research suggests that robo-advisors will manage 10% of all global assets under management by 2020, or about $8 trillion.
There are pros and cons to all financial management services, and robo-advisors are no different. If you are considering automating your investing decisions, these are the advantages and disadvantages you should keep in mind before you make your choice.
Advantages of robo-advisors
Although there are different pricing models for financial advisor services, few can compete with the fees of the cheapest robo-advisors. Human advisors generally charge between 1% and 2% of assets under management for their services, while robo-advisors cost as little as 0.25%. Betterment, the largest and older of the stand-alone robo-advisor platforms, offers one year free before imposing a modest 0.25% management fee, or $25 for each $10,000 invested. They also waive most transaction fees and commissions associated with buying and selling funds.
Low to no account minimums
Most financial advisors only work with clients who already have a substantial portfolio, although those working on an hourly fee structure may take smaller investors. Robo-advisors, on the other hand, generally have no account minimums, or minimums of $500 or less. This is especially true of stand-alone platforms such as Betterment and Wise Banyan.
Many of the big-name financial management firms such as Fidelity, Vanguard, and Charles Schwab also offer robo-advisor services, usually in combination with more traditional wealth management services. These platforms tend to impose account minimums for access to robo-advisor technology however, typically starting at $10,000.
Access to cutting-edge portfolio research
Robo-advisor technology is powered by algorithms designed by Nobel Prize-winning economists such as Robert Shiller and Eugene Fama. The investment theory behind robo-advisor platforms takes the human element out of investing, relying on statistical analysis to create portfolios that minimize risk and maximize returns.
Simplicity and availability
The average user, with just a few clicks, can open an account and build a portfolio with a robo-advisor in a matter of minutes. A distinct advantage over time-intensive human financial advisor services. There’s also the convenience factor of 24/7 access to your robo-advisor.
There’s a body of research showing regularly rebalancing your portfolio to its original asset allocation is key to high performance. Individual investors rarely make the effort to rebalance, and a financial advisor charges a fee for the service. Robo-advisors automate the periodic rebalancing process, usually on a quarterly basis, so that your assets are always invested in line with your preferences and financial goals.
Most actively managed funds fail to meet their benchmark returns, especially over the medium and long term. Robo-advisors typically invest in ETFs, which are passively managed funds pegged to an underlying index. Generally speaking, ETFs and index funds do a much better job of matching returns. They are also low-cost investments that don’t eat away at your gains with high expense ratios and fees.
Disadvantages of robo-advisors
Most robo-advisors have a set of portfolios and plug each client into the portfolio that most closely matches his or her investment goals and risk tolerance. They have a limited set of responses to each financial situation, so they may not make sense for people with unusual financial situations outside the “one-size-fits-all” portfolio.
No “human touch”
It’s hard to overstate the role that emotions play in financial decision making. A declining market or an unexpected personal financial downturn can drive bad investment choices and transactions that are easily executed with a robo-advisor platform. Human advisors, on the other hand, are there to offer perspective and game out different scenarios to help investors avoid rash decision-making regarding their portfolio.
Lack of integration
Robo-advisors excel at simple financial planning tasks such as retirement calculators and balanced asset allocation in taxable accounts. Where they fall flat is in integrating all your financial needs, such as tax and estate planning, into one cohesive plan.
Robo-advisors focus almost exclusively on ETFs; few trade individual securities or offer other asset classes to round out your portfolio. In addition, risk management strategies such as options, are beyond the algorithmic capabilities of a robo-advisor.
The robo-advisor industry is still in relative infancy, and newer platforms may address some of the limitations that are inherent in the automated investment management model. Ultimately, the decision to use a robo-advisor for some or all of your portfolio depends on your overall investment goals and personal style.