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What is a Robo Advisor & Is It The Right Choice for You?

What is a Robo Advisor & Is It The Right Choice for You? 2

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Robo advisor is a method to automate the asset allocation of investments via a computer algorithm. In a broader sense, a Robo advisor may also include human financial advisors but only for services that require human assistance (e.g., taxes, retirement, or estate planning).

Robo Advisors Effect On Investing

Overall, the rise and interest in Robo-investing services are considered a good thing, pushing down the costs of high-fee Wall Street advisors who offered no real value and, if anything, were a drag on returns. This is positive in any competitive marketplace. These firms are also helping individuals who typically have no clue where to begin — with goal setting and asset allocation.

As with almost everything, one size does not fit all when it comes to financial advice. However, I do see this space-filling the need of most beginner investors and investors with uncomplicated financial portfolios.

Is Robo Investing Right for You?

The answer to this question depends on your net worth, your investments’ complexity, and whether you feel comfortable enough doing it yourself. I’m not in the camp of those who say that these Robo advisors add no value and that you could easily replicate their results yourself just by using Fidelity or Vanguard funds.

In my case, most of my family assets are DIY, but I’ve also been studying Robo advisors for years and feel comfortable using them. Other individuals may not, and I get that.

Which Kind of An Investor Are You?

Do-It-Yourself Robo Advisor Financial Advisor
Cost Low Medium High
Investment Flexibility High Low Medium
Account Minimums Low Low High
Time & Research High Medium Low

Keep in mind that what Robo advisor firms are offering is not unique. A target-date mutual fund has some similarities. All of the Robo advisor firms base their automated investment guidance on Modern Portfolio Theory (MPT), Efficient Market Hypothesis (EMH), and a series of questions to determine your risk profile.

While this investment strategy isn’t perfect, it sure beats what most individuals have: nothing. In reality, inexperienced investors usually have a hodgepodge of investments with no asset allocation, actively managed funds, high annual fees, and whatever “stock du jour” their peers recommend investing in.

Firms like Wealthfront focus on the end goal and are ideal for individuals who don’t care or who don’t want to learn about the details of investing. For these individuals, the 25 basis points (otherwise known as a 0.25% annual fee) or less they pay is well worth it and, in many cases, much better than hiring an FIA — in terms of both cost and good financial advice. Here’s q quick overview of our recommended robo advisors:

Further Reading>> Best Robo Advisors

Is the Technology New, and Can It Be Trusted?

The online tools Robo advisors offer aren’t new. Traditional financial advisors had the same tools available to them for years and could roll up a personalized asset allocation plan specific to you. Heck, this stuff was available in 1999 when I first used an advisor at PaineWebber. Like self-checkout at Home Depot ( HD), this is pushing the technology down to the masses. You have direct access to manage your account, and it removes the non-value-added middlemen.

Let me be clear: Some financial advisors can add tremendous value. They can give guidance to the asset allocation best for you based upon unquantifiable factors, which computer programs can never do. But I believe this is more the exception than the rule.

Financial advisors can give recommendations about long-term life decisions (e.g., helping plan for a child’s education through a recommended action plan). Some of the Robo advisors mentioned in this article are just tech-assisted firms and not 100% automated. If you want it, the human element is not entirely removed from the loop with some of these firms.

There’s something to be said for any 100% algorithm-driven investment approach. While it might help with a high percentage of individuals, there are always cases in which automated guidance isn’t appropriate.

Can Robo Advisors Replace Traditional Advisors?

Previously, when investing, your choices were pretty limited. You had only two options to choose from:

Historically, there’s been a problem with trying to get an FIA: Many have minimum asset requirements of $500,000 or more. These requirements put many FIAs out of reach for younger and lower-net-worth individuals.

Also, it’s not uncommon for FIAs to charge 1-2% annually (or even more via the loaded investment products they push you into). That’s 1-2% you have to do better than the market to keep up. As history has shown, this is a steep fee to overcome, and in many cases, FIAs also came with substandard financial advice to boot.

Let’s also not forget that — if the investment advisor isn’t a fiduciary — they may not offer investments in your best interest but recommend investment products that best line their wallets. However, there are services you can use to find a fiduciary near you. For example, the Paladin Registry is can help you find a pre-vetted fiduciary, and it’s completely free to use.

If you went the DIY route, you might have found you aren’t cut out to go it alone. Gone are the days when everyone who retired automatically got a gold watch and a pension (which was managed by a professional). Today you are required to self-fund your own retirement.

401(k) plans and IRA accounts put you in the investment driver’s seat. But it’s more than likely you haven’t read up on investment analysis. Worse yet, you may have poor investing psychology and jump out of the market at the absolute worst times (buying high and selling low).

Further Reading >> Robo Advisors vs. Financial Advisors

Should You Choose to Invest With a Robo Advisor?

The ultimate question is: Should I use a Robo advisor instead of doing it myself, or should I use a traditional advisor? In many cases, yes, a Robo advisor is a solid choice.

A Robo advisor is a good fit if you:

  • Are Young — with more than 20 years till retirement?
  • Have a Simple Portfolio — no accounts with other financial services.
  • Lack of Investment Experience — You’re unsure about where to begin.

They don’t cost much to use, and in my opinion, most create a decent asset allocation. These services will give you a good starting point.

As your needs change, you could always move your money to another financial service. By then, some of these same services will have advanced and might automate more of what previously required a human.

Are they perfect? No. If you have the skills, you might be better off rolling your own, or a target-date fund may be all you need. But then again, that’s not the audience these companies are targeting. They’re filling a niche in the investment advisory space that’s been ignored for years.

If you want estate planning or have issues that don’t fit the typical investment planning mold (e.g., you have a child with special needs), you might be better off with a traditional advisor. Or a robo advisor service that can help customize your asset allocation.

What is a Robo Advisor & Is It The Right Choice for You? 4

In my opinion, however, it’s no question robo advisors are the future of the financial industry for the most basic advice.

Just as Vanguard revolutionized investing in indexed-based low-cost funds, Robo advisors are doing the same with asset allocation for the masses.

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