Whether you use Siri, rely on Alexa, or just have a Roomba, there’s no escaping the fact that bots are more part of our lives than ever before. And that’s not necessarily a bad thing. After all, why not automate life’s mundane, tedious tasks? Depending on how you feel about your finances, you could even get some robots to help you with that too.
Robo advisors have joined the mainstream, whether they look like Silicon Valley tech startups or they’re owned by old-school, traditional financial firms. It seems like there’s a robo advisor for every need and preference, which can provide an appealing investment solution, especially if you’re new to investing and don’t know where to start.
Before jumping on the investment automation bandwagon, you have to think about the pros and cons of going robo – and whether a robo advisor makes sense for your unique situation and goals.
How a Robo Advisor Can Work for You
Robo advisors automate the investing process. Their investment strategies and the portfolios they offer to users are based on Modern Portfolio Theory and the Efficient Market Hypothesis.
Robos use a process to determine exactly how to invest on your behalf:
- You sign up and take a short survey to provide your answers to a few investment-related questions.
- The robo advisor plugs your answers into an algorithm that determines the specific kind of portfolio and asset allocation appropriate for your age, risk tolerance, and time horizon.
- You make your first contribution to your investment account, and the robo advisor invests the money on your behalf.
You can get started, but you don’t have to worry about making complicated investment decisions or worrying about whether you’re doing everything exactly right, which is perfect if your eyes glaze over at the first mention of ETFs or mutual funds. That said, you need to understand that robo advisors provide services, not financial planning – which is a critical component of financial success.
Service, Not Guidance
Investment management and financial planning are both important, but they’re not the same thing. Financial planning provides you with an actual human advisor who can educate and guide you to where you want to be with your money. That’s an ongoing process that includes personalized attention and, importantly, accountability. It’s a long road to financial success, and having someone to keep you on track can make all the difference to whether you achieve your goals or not.
Services like investment management from a robo advisor provides you with options and solutions, but without context. Even though the process is mostly automated, it’s still up to you to avoid doing things like:
- Forgetting to contribute to your investments
- Not increasing your contributions over time
- Selling low or buying high
- Panicking and making irrational investment decisions (like drawing out all your money at the bottom of the market, which can destroy your wealth)
Think of it like this: a student can sign up for any class offered by the local college. That’s a service the college provides. But to make the most of their educational experience, the student seeks the advice of an academic advisor. The student uses the guidance, advice, and accountability of the advisor to choose the appropriate courses for them that will get them to their goal of graduation on time, and they rely on the advisor through hard times to make tough decisions. That is planning, and financial planning can provide you with similar benefits as you invest and build wealth.
Are There Upsides to Robo Advisors?
This doesn’t mean a robo advisor is a bad idea. They provide benefits to specific kinds of investors with a certain set of needs. Here are some of the upsides of using a robo to get started on your wealth-building journey:
It’s low(er) cost
Working with a robo advisor provides a low-cost solution to investors who are just getting started. Lower costs mean more money to invest.
The fees from robos can be less than human advisors, although this difference can be less than you think. Robo advisors also can’t take your long-term lifestyle goals into account, and a successful investment strategy always aligns with those goals.
Fees are also low because robos typically invest in index funds and ETFs. But you can also easily do this on your own if you choose; most robos use solutions like Vanguard funds and ETFs which are available to the public without having to pay the robo advisor fee that is added on top to the underlying mutual fund or ETF fees. When weighing that value, you should take into consideration the automated re-balancing and tax-loss harvesting most robos provide.
It’s accessible
Even Vanguard requires you to have a few thousand dollars to invest with them. Robos can require as little as $0 to open an account with them. This enables younger investors to build wealth earlier, which is critical when time and compounding interest are your greatest advantages to increasing your nest egg.
It’s fast and simple
Create a username and password, answer a few questions, and you have an investment account! Robos offer one of the simplest, fastest ways to go from saver to investor. From there, you can automate deposits and create a variety of investment accounts.
Robos not only invest automatically for you, but they do important tasks like rebalance and handle tax loss harvesting, too.
What to Think About Before Considering a Robo
Remember, you can always pick up the phone and talk to your financial advisor. The value of a two-sided conversation is worth its weight in gold. While some robos offer “customer service,” your call goes to a call center. An advisor might be at the other end, but they won’t be your advisor you have a relationship with.
Along those same lines, an advisor can provide insight that a robo can’t. Emotions can cloud the judgement of even the most battle-tested investor. The urge to sell during a downturn or chase after underperforming stocks is human nature and can be hard to fight on your own.
An human advisor can help clients balance emotions with practical advice and judgement. A robo? Well, you’re automated – but you’re also on your own.
And while robo advisors offer simplicity, simple isn’t always the best approach. Lifetime goals and plans can’t always be determined by a few questions and answers.
While robo advising takes away the need for expertise, it also takes away important context and subtle nuances. A robo’s reasons for choosing a portfolio can be completely different than an investor’s.
The Bottom Line: Here’s When You May Want a Robo
Robo advisors are a great option for entry-level investors because of their low fees, low cost threshold, and ease of use. If you have $25,000 or less, robo advisors may be a great option for you to help you get started.
Investing for the long term and growing your wealth beyond this level, however, requires the experience and guidance of a qualified financial and investment advisor. These advisors provide customized, holistic solutions – and they can also offer investment options not available on robo-platforms.
A strategic approach that goes beyond index funds is important if you want to build your wealth beyond the low six figures. And human advisors can adapt to life’s curveballs in a way that even the best AI can’t manage just yet.
Robo advisors provide an excellent starting point to building wealth. Financial advisors provide the options, accountability, experience, and nuance to reach your goals.
Eric C. Jansen, ChFC is the founder, president and chief investment officer of Westborough Massachusetts–based Finivi, which provides fee-based retirement income planning and investment management services for successful individuals and families nationwide. Do you need help planning for retirement? You can click here to request a complimentary consultation with a financial planner.
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