What's a robo advisor? If you're considering using robo advising services, here's what to know about robo investors and how they're impacting investments.
Robo advisors are a great way to get into investing while saving time and money. These automated services rely on algorithms, so they take the human element (and expense) out of devising an investment strategy and portfolio. You don’t have to pay the fees or meet the account minimums required with traditional financial advisors, but you do not have to do the investing yourself either. Robo advisors are not all the same, though.
Here are five things to consider when selecting a digital advisor:
1. Potential Bias
Some digital advisors are associated with money management firms and may be programmed to give preference to their firm’s funds or to use certain products not because they are cheaper, but because they generate commissions. On the other hand, human advisors may have these biases and others, such as favoring products that get on their radar through industry media and digital marketing.
The decision-making of robo-advisors can be more objective, and one thing is certain—they can monitor multiple assets simultaneously at much lower rates than their human counterparts.
2. Strategic Limits
Robo advisors, relatively new to the market, haven't experienced a bear market in stocks. They typically track low-cost, exchange-traded funds (ETFs) traded on stock exchanges. These are considered “passive,” because they typically track an index, such as a stock or bond index.
Taking more active management of the portfolio can be done with a robo advisor hybrid, which also offers human assistance. This can be the answer to addressing market downturns or a way to counsel clients through a financial crisis.
Some robo advisors blend software and human-guided strategies. After your portfolio is created and assets are allocated, managers will make adjustments to address shifts in the financial markets.
Robo advisors may still be preferable in a bear market—compared with using a traditional financial advisor and paying fees of 1% to 2% to lose money during a market turndown.
Keep in mind, too, that U.S. robo-advisors are required to be protected by the nonprofit Securities Investor Protection Corporation. The SIPC insures you for up to $500,000 in the off chance that a member firm, broker or robo-advisor goes bankrupt or your assets go missing.
3. Financial Goal Focus
Robo advisors strive to be strategic in meeting your financial goals, such as saving for retirement or for a child’s college education. Some say the online questionnaires might be too simplistic, however, to adequately evaluate your financial situation and needs.
These are other instances in which a robo hybrid involving some human help can help you finesse financial goals or reprioritize them in the face of changes in your life.
Tapping the insight of a real person who can understand special or more complex situations can fill in the gaps of software.
4. Features and Fees
Robo advisors offer a range of services—and fees, so it pays to compare them and find what works best for you. When it comes to fees, a few platforms charge none, but most have fees ranging from 0.15% to 0.40%, depending on the amount that you invest. For example, an annual fee of 0.20%, amounts to $20 on a $10,000 account, and some platforms have much lower or zero minimum account balances.
If you select ones with features such as a robo hybrid, which includes some assistance from a human advisor, that comes with a higher fee. Remember that management costs carry a double impact. Every dollar that goes to fees also diminishes your investment power by a dollar—with that much less to potentially grow.
5. Managing Risk and Saving on Taxes
When you first create your portfolio with a robo advisor, the assets are allocated according to your desired risk and your financial goals, whether it’s saving for a home or retirement. To maintain that allocation, many robo advisors offer automatic rebalancing, in which their algorithms re-evaluate the allocation, then adjust through buying and selling assets.
This is important for keeping your plan on track, or to change it. For example, young investors can typically be more aggressive investors, because they have more time to take risks. People approaching retirement, however, usually shift toward more conservative investments.
When it comes to taxes, tax-loss harvesting is what advisors use to minimize the amount of taxes you have to pay on capital gains. This complex task is better left to algorithms that can be more unbiased and efficient than humans. The programs can quickly and strategically identify and sell assets at a loss to offset realized gains and replace them with similar assets.
Robo advisors offer a range of benefits to neophytes as well as experienced investors. Considering these key points can guide you in choosing the automated advisor that's best for you.