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. The best robo-advisors may be entirely automated, while others offer access to human assistance. Regardless of the model, they all provide customer service to assist you through the process.
The overriding idea behind these 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 financial advisors.
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 increasingly popular among investors who want to access the markets.
- Tobo-advisors are low-cost, often have no minimum balance requirements, and tend to follow strategies suited for new and intermediate investors.
- They do not offer many options for flexible investing, and they reduce the human interactions that are sometimes critical when investment planning.
Everything You Need to Know About Robo-Advisors
Advantages of Robo-Advisors
Robo-advisors come with many benefits. This is especially true for retail investors who don't have a lot of capital to work with and are novices or have a rudimentary knowledge of the investment world. They allow you to craft smaller portfolios without a lot of the hassle and investors don't have to deal with pushy advisors trying to lock in a commission. Having said that, the following are the most common advantages of investing with a robo-advisor.
Lower Fees
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, there are no advisory fees or commissions for those who use Charles Schwab's Intelligent Portfolios while the Wealthfront and Betterment models also favor cost-conscious consumers.
Robust Investment Models
Many of the algorithms used by robo-advisors, such as Betterment, 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 Account Opening
It's becoming more common for traditional financial planners to white label robo-advisor platforms for their clients. This takes the cumbersome task of choosing assets out of their hands so financial advisors can spend more time with their clients addressing individual tax, estate, and financial planning issues.
Some consumers, such as 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 over the do-it-yourself investing model.
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.
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 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. But, if your primary concerns 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 technology advances, there will be more services offered by robo-advisors and more choices for investors.
Disadvantages of Robo-Advisors
It may seem like an easy decision to invest using a robo-advisor, but it's always a good idea to review the drawbacks. Remember, you don't get the human service you would with a financial advisor guiding you through your investments. And despite the low cost, you may end up paying more in fees in the end. Here's a look at some of the most common disadvantages of using a robo-advisor to invest your money.
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.
As such, you may benefit from talking to a human being who can help tailor your investment plan to your specific situation—something you won't get using a robo-advisor.
Limited Flexibility
Most robo-advisors won't be able to help you if you want to sell call options on an existing portfolio or buy individual stocks. 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.
Robo-advisors use algorithms to automate trading. Robo accounts can be accessed through the internet and your devices.
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 won't hold your hand and comfort you after a significant market drop. By 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 cannot take a holistic view of your financial life.
May Be More Costly
Robo-advisors often charge fees, which vary based 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.
It's also important to 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.
Pros
Fees are lower than traditional financial advisors
Robust investment models
Account opening is easy
May have lower account minimums
Cons
Personalization is limited
Limited flexibility
Completely automated so there is no human contact
May be more costly than doing it yourself
History of Robo-Advisors
The first robo-advisors launched after the financial crisis that led to the Great Recession. The goal was to provide investors with low-cost alternatives to invest their money. As noted above, robo-advisors sought to use artificial intelligence (AI) and machine learning to create and manage investment portfolios instead of the human touch.
Betterment and Wealthfront are commonly credited as being trailblazers when it comes to being the first companies to offer algorithmic trading services to investors who demanded more transparency and control over their finances. Larger, more traditional firms like Charles Schwab began to take notice and jumped into this pool.
The model proved to be popular among many investors, especially younger and tech-savvy individuals. As of 2023, this market was valued at $7.39 billion in 2023. That figure is expected to grow to $9.50 billion in 2024and $72 billion by 2032. The industry can expect to see as many as 34.13 million users by 2028.
Evaluating Robo-Advisors
One critical issue when deciding whether to use a robo-advisor or to choose a platform is to consider 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 ETFs?
The ups and downs of the market can impact the investments selected by the robo-advisor's algorithm. For instance, robo-advisor returns mirrored the downturn and the recovery following the COVID-19 pandemic. A robo-advisor needs to consistently exceed market returns to prove its worth.
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 tops the rankings for generating the best returns over three and 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.
How Can I Determine 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.
