Online Investment Platforms: Wave of the Future or a Passing Fad?

Last week, we looked at how the asset allocation process doesn’t have to be an overwhelming task and that a variety of options exist to create a diversified portfolio.  As we continue to examine different ways to create an investment plan that matches your life goals, it is important to understand where you can turn to for asset allocation guidance.  After all, financial literacy research studies demonstrate that most people do not have the financial knowledge and confidence to manage their own investments.

One option for investment guidance that is growing in popularity is the use of both free and fee-based online investment advisors. The benefits can be significant as services such as performance tracking, asset allocation, and automatic re-balancing are available to help make sure that investments are consistent with financial life goals. Many investment industry professionals use the term “robo-advisor” to categorize these online investment platforms.  Do their sophisticated investment algorithms hold the keys to help everyday investors make effective investment decisions?

An important aspect of determining an optimal level of diversification involves assessing your risk comfort or risk tolerance. Traditionally, financial advisors either use personal interviews, including goal discussions, and risk tolerance questionnaires to assess investor risk.  Online investment platforms almost exclusively rely on risk questionnaires.  Many of these brief questionnaires have been created based on research but some academic studies question the ability of individual investors to appropriately assess their own capacity to accept risk.  Don’t we all want to obtain the highest investment returns with as little risk as possible? Over the past 5 years we have for the most part witnessed solid stock market returns so professional guidance can be invaluable in managing expectations and investor psychology.

Perhaps the biggest appeal of online investment platforms is that they are seen as disrupters when it comes to getting low-cost access to professionally built investment portfolios. Costs are often viewed as one of the few things we have control over as investors along with asset allocation and minimizing taxes (asset location). Online investment advice platforms generally use low-cost investments such as ETFs and no-load mutual funds to fulfill asset allocation suggestions that are usually based on brief risk tolerance questionnaires.  This low-cost approach uses passive, diversified investments that don’t try to “beat the market.” (Yes, it is possible to outperform the market through active investing but most research studies demonstrate that the odds are not in favor of this approach and it’s nearly impossible to pick outperforming money managers in advance.)

Some financial planners question the rising popularity of online investment firms because they often lack a personalized approach to investing.  Since investment planning is just one part of the financial planning process, I agree with these concerns. I’ve come across too many personal investors who equate having an investment portfolio to having an actual financial plan. The majority of online investment providers do not provide comprehensive financial planning services but if you are thinking about seeking a lower cost investment management alternative (see “When to fire your financial advisor”) or just want to continue the do-it-yourself approach, you can always use your company’s financial wellness program (if available) or consult a fee-only financial planner that provides unbiased financial planning guidance.

Here is a list of some of the online investment advisers (in no particular order) that I have come across in the past few years (please note this is not an endorsement of any one company!):

Financial Engines (often available through retirement plan sponsors)

Betterment

Wealthfront

Personal Capital

SigFig

Not interested in turning over your investment management decisions to someone else?  That’s okay because you can still use free resources available from some of the following companies that don’t directly provide investment advice. Free asset allocation monitoring services and performance tracking can be helpful in looking at your total investment portfolio together as a whole.

Personal Capital (account aggregation plus online budgeting tools)

SigFig

NextCapital

Mint.com (very basic monitoring)

Should you consider using an online investment platform to create or monitor your asset allocation plan?  This will become an increasingly important decision as the capabilities of online investment advisors continue to grow and their analytical strategies get tested through good and bad investment markets. If you need a little guidance along the way then a “robo-advisor” could be a good source of asset allocation guidance to help increase your investment knowledge and confidence.  (If you choose to use their investment management services, be aware that the fees vary significantly across these investment advisers so always do your homework.) The main thing to remember is that investing is just part of an overall financial plan. Be sure to focus on your personal goals and never hesitate to seek a second opinion.

 

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