Technology has revolutionized everything from choosing a restaurant to getting directions or even a ride to that restaurant, but is it time for technology to get you to your investment destination as well? While this may sound like science fiction, the rise of “robo-advisors” over the last few years has made this into a plausible option.
These online automated investment services can provide investment advice or management for typically a lot less than a human advisor. But should you really entrust your nest egg to a computer and if so, which of the many options would make the most sense for you?
Pros of robo-advisors
- It’s convenient. You don’t have to have a large amount to invest or go to a fancy office and talk to a pushy salesperson. Most robo-advisors have very low minimums and allow you to set up and fund the account from the comfort of your smartphone or at least, your computer.
- You get a customized asset allocation. “Asset allocation” is a fancy term for dividing your money into various types of investments (called “asset classes”) like stocks, bonds, and cash. Rather than having to make this decision on your own, robo-advisors generally do this for you based on your responses to questions that are designed to determine your time frame and comfort with risk. All you need to do is then fund the account.
- The costs are relatively low. You could get asset allocation advice from a human advisor, but that typically costs about 1% of your assets. They may also put you into funds with high fees. Robo-advisors generally charge a lot less and use low cost index funds.
Cons of robo-advisors
- The “advice” is very limited. Robo-advisors generally only help you with your investments. You typically won’t get help with other financial planning issues like how much you should be saving, what type of accounts to invest in, and whether you have adequate insurance coverage and estate planning. The investment advice you do get may also not incorporate taxes or how your money is invested elsewhere.
- There’s no “hand holding.” One of the most valuable services of an advisor is to talk you out of doing something stupid – whether that’s putting too much in an aggressive tech stock or bailing out when the market takes a downturn. To the extent that robo-advisors do this, they still lack the emotional connection and persuasive/motivational ability of a trusted human advisor.
- There are generally still advisory fees. Even a small advisory fee can add up over time. You could do a lot of what robo-advisors do without paying their fees by simply investing in an asset allocation fund that matches your risk level or taking a risk tolerance questionnaire and following the asset allocation guidelines.
How to get started if a robo-advisor is what you need
- Know what you’re looking for. If you’re investing in a taxable account, you might want to look for a robo-advisor that offers tax-efficient investing and/or tax loss harvesting. A few offer access to a human advisor by phone. Make sure you’re also comfortable with the program’s investment strategy.
- Know your options. Your employer’s retirement plan may offer a robo-advisor program. Some are also offered by particular brokerage firms for their clients. You can find a good comparison of options here.
- Know what you’re paying. Look at both the fees that the robo-advisor charges and the expenses of the funds it recommends. “Free” robo-advisors typically put you in their own bank accounts and mutual funds, which may be more expensive than another program’s fees.
For investors who are looking for investment management or advice but are unwilling or unable to hire a financial advisor, robo-advisors can offer a simple and relatively low cost solution. (Just be aware of their limitations.) At the very least, they will make human advisors work that much harder to earn the fees they charge.