Robo-advisors are a great substitute for personal financial advisors. They can do can most of what personal financial advisors can do for a fraction of the cost. It’s not a surprise that they have been in the news a lot lately.
What is Robo-Investing?
Robo-advisors invest money based on algorithms. These digital advisors use technology to build your portfolio and optimize your returns based on your risk profile. While an automated portfolio brings a lot of advantages, it also has some disadvantages.
Pros and Cons of Robo-Investing
Pros of Robo-Investing
Low-cost index-based ETFs
Robo-advisors construct portfolios using low-cost index-based ETFs. Research shows that low-cost index funds beat actively managed funds by a mile. Robo-investing fees can be as low as 0.25% of assets invested.
Easy to use
Robo-advisors make investing easy. You can get started by answering a few simple questions about your goals and risk tolerance. These companies will build a portfolio based on your risk profile.
Unlike traditional advisors, robo-advisors don’t have minimum balance requirements. So you can get started with investing even if you don’ have a lot of money.
You don’t have to tinker with the portfolio every few months. Everything is taken care of automatically giving you time to focus on other important things in life.
Tax efficiency
If you are investing in a taxable account, robo-advisors will automatically maximize your after-tax returns by tax-loss harvesting. Tax-loss harvesting involves selling some of your securities at a loss to offset capital gains liability.
Some robo-advisors also offer automated asset allocation, which has been shown to increase returns.
Cons of Robo-Investing
Great for retirement investing but not so great for other goals
Robo-advisors are great at creating investment portfolios for retirement. But they are not good at helping you build an emergency account or building a plan to get out of debt. Short term financial goals are important because they give you the stability to build long term wealth.
Lack of human advice
Robo-investing is working with a technology-enabled platform. Sometimes investors need to be able to talk to a personal advisor to discuss strategies or plans. Though some robo-advisors offer this option, not all of them do.
Not the cheapest investing option
One of the selling points of robo-investing is that its expenses are low. But there are cheaper options available. The average Vanguard target-date retirement fund charges 0.10% per year. Robo-advisors like Wealthfront and Betterment charge 0.25%
Robo-funds are not good at adapting to changing life circumstances such as marriage, having kids, changing income, etc. These funds ask you a standard set of short questions to build a risk profile of a client. But circumstances and risk profiles change with time and robo funds don’t adapt investing strategies in the same way that a financial advisor might.
Limited investment choices
If you need to invest in complex investment vehicles, then robo-advisors may not be able to help. You will need to find a traditional advisor to invest in complex personalized portfolios.
Bottom Line
Robo-advisors make it easy for investors to invest. By using technology effectively, these firms can keep costs low for investors. Robo-advisors optimize returns by tax-loss harvesting and improved asset allocation.
Though some robo-advisors have the option to talk to a human financial advisors, most don’t. Robo-advisors do a good job of building portfolios with simple ETFs, they won’t help you if you need to build portfolios with complex investment vehicles.