What Is A Robo-Advisor And Should You Use It?

What Is A Robo-Advisor And Should You Use It?

Robo-advisors are online services which help you work towards your financial goals. They come at a low cost and with little to no minimum investment. They work equally well in upswing markets (bull markets) as well as downswing markets (bear markets). Even in the current stock market coronavirus crash they are excellent. They don’t panic sell, they don’t invest with emotions but they work according to rules.

Where does your mind jump to when you hear about robots taking over industries? Automated robots moving inventory in a warehouse? Or a factory line where a lonely, single mechanical arm does nothing but screw in bolts all day? You might even think of automated cars and trucks that will drive without a driver. These are all examples of how robots are boosting productivity in the business world. And now robots have entered the investing world.

Investing is a difficult thing to master. Even the world’s best financial advisors can make crucial mistakes. Or have trouble to produce consistent long-term returns. With the introduction of Robo-advisors, that is beginning to change. Robots changed the assembly line. Robo-advisors are starting to change the way in which people handle their money.

What Is A Robo-Advisor?

A Robo-advisor is a financial account automatically managed by a computer algorithm. It offers a relatively hands-off way to invest your money. Think about the big computers and algorithms used by companies like Goldman Sachs and E*Trade but now this technology is available to you.

The difference between a financial advisor and a Robo-advisor is that a Robo-advisor is essentially a computer. This computer is programmed to invest your money on your behalf.

For an investor, Robo-advisors work pretty simple:

  • Your profile – You define your investing goals, preferences, risk tolerance and how much money you want to invest.
  • Investment selection – The algorithm selects the financial instruments based on your profile. Mostly low-cost mutual funds and exchange-traded funds (ETFs) and are chosen for your portfolio. The ETFs are often based on financial indices which form a basket of financial instruments. Examples are the S&P 500, the Dow Jones Industrial Average, the EURO STOXX 50 or the MSCI World Index.
  • Regular rebalancing – The Robo-advisor balances your portfolio automatically. It does this on a regular basis over time or whenever you invest or withdraw money.
  • Additional services – With most Robo-advisors, you get additional services: financial planning tools and tax optimization strategies.

What Does A Robo-Advisor Cost?

Another difference between a financial advisor and a Robo-advisor is the costs. Robo-advisors are much cheaper. Most companies charge between 0.25% and 0.5% as annual management fee. This fee is paid as a percentage of your investment assets. For an account balance of $10’000 you could pay as little as $25 per year.

In a normal brokerage account, you often pay commission to buy or sell investments. With a Robo-advisor, you usually don’t have to pay transaction fees.

Why Robo-Advisors Are Great

Investing money has always been tricky. There are so many factors to consider that it’s difficult to know what the right decision is. With the advent of the internet, people’s access to information has only increased. Stock prices adjust to earnings reports and other factors split seconds after they are released.

In investing, access to information is everything. Stock prices reflect all available information. In fact, information is so valuable that a group of investors actually paid to build a fiber-optic cable. This cable connects the stock exchange in New York directly with their office in Chicago. It gave them a split-second advantage over their competitors in Chicago who were still using copper lines.

Even if you focus only on mutual funds and ETFs, the choices are huge. It can easily be overwhelming to find the right investments for your profile.

Leaving investment decisions up to computers might sound somewhat risky. But this concept is used incredibly often by professionals. In fact, famous investor Ray Dalio created one of the most valuable companies in the world by teaching computers to make investment decisions for him and his clients.

If you are new to investing, Robo-advisors do all the investing work for you. Most of them even help you figure out exactly what your investing goals are and will take it from there.

Let’s take a look at some of the advantages and disadvantages of using Robo-advisors.

Pros Of Robo-Advisors

  • Low Cost – Traditionally, financial advisors are very expensive. They typically charge a portfolio creation fee of anywhere from $1’500-$2’500 as well as 1-2% yearly after that. Compare that to the portfolio creation fee of Robo-advisors (which is $0) and the yearly fee (between 0.25% and 0.5%). Now Robo-advisors start to make sense.
  • Low Minimum Balances – One thing that can deter investors (especially younger ones) is the required minimum balances. Most traditional brokerages will say that you need to have anywhere from $1’000-$5’000 to get started. With Robo-advisors, there is rarely any required minimum balance.
  • Access To Financial Advice – Investing used to be a rich person’s game. You really only sought to invest money if you had a lot of money. Therefore, if you didn’t have a lot of money you didn’t need to know a lot about investing. Robo-advisors are growing the market for financial services. Hence they are also growing the market for financial advising.  
  • Transparency – Robo-advisors are incredibly transparent. Through their app or website, you can see exactly where your money is invested. And how your investments perform. Most companies will even send you detailed monthly, quarterly, and yearly performance reports.
  • Performance – There is enough data available to prove that Robo-advisors have a good track record. By using a Robo-advisor, you can expect a dependable, satisfactory return on your money.
  • Tax Efficiency – You wonder if you will need to hire an accountant to handle your taxes once you start using a Robo-advisor? Think again! They make it easy to file your taxes and most will have software that links to TurboTax to make filing automatic.
  • No Emotions – Robo-advisors stick to the defined investment strategy. Always and based on rules. If you invest yourself, you might panic sell when you see a negative performance. Or you might over-invest because you have got this feeling that another upswing is about to start. Even during crises like the stock market coronavirus crash, a Robo-advisor will simply continue its strategy as always.
  • Crisis-proof investments – Robo-advisors lead your portfolio through turbulences on the financial markets. The actual coronavirus crisis is one example. Yes, your portfolio’s value might decrease temporarily. Your Robo-advisor will ensure that your investments match your pre-defined risk profile. On the long run, this will give you the best possible return on investment

Cons Of Using Robo-Advisors

  • Flexibility – Most of the packages that Robo-advisors offer are prebuilt. They might offer little flexibility if you’re looking for something more customizable. This may create a problem for investors who have advanced investment preferences.
  • No Face-To-Face Meetings – Although having a financial advisor can be pricey, you’re also paying for the customer service. A financial advisor might give you reassurance. You know that there is someone who has a personal vested interest in your finances.
  • They Don’t Guarantee Performance – Robo-advisors generally have a good track record since their creation. However, results are not guaranteed. As with anything in the investing world, there is an inherent risk. Even the most sophisticated computers in the world can’t guarantee that you won’t lose money when investing.
  • Intuition – As great as computers are, they are still unable to match the intuition of humans. They can’t trust their gut or go against their programming. But that’s actually more an advantage.

Good Platforms To Get Started

Betterment Logo

Betterment is one of the most forefront companies in Robo-advisors. They have actually been around for over 10 years. They offer a simple platform with many good features. Betterment does not require a minimum balance on your account. They offer competitive pricing: 0.25% for the digital plan which is fit for most customers. 0.4% for the premium plan which offers in-depth advice on higher balances.

Wealthfront Logo

Wealthfront and Betterment are essentially the Uber and Lyft of Robo-advisor investment firms. Wealthfront offers a strong financial planning component but requires a $500 minimum investment. In return, the fixed 0.25% annual fee only gets applied on portfolios over $5’000.

M1 Finance Logo

M1 Finance offers a simplified Robo-advisor platform. You can select your own individual stocks if you like, too. You can either get a pre-built portfolio, customize your own or do something between. M1 is completely free.

Acorns Logo

Acorns is an app-based Robo-advisor. It makes it easy to invest amounts starting from $5 per month. It is free for investors under 24 and students. For all others, it is $1 per month for portfolios under $5’000 and 0.25% per year above $5’000.

Take Action

The most important step in anything related to investing is to always take action. You can perform the most detailed research possible but if you fail to act on it then it won’t do anything to help you. If you decide for Robo-advisors into your investment strategy, it’s imperative to take action and put them in place.

What Is A Robo-Advisor and Why You Should Use It

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