Investment management advice has long been a luxury enjoyed by a relatively narrow audience. Today, however, a much broader, economically diverse demographic is turning to robo advisors to guide them in making investment decisions.
Not only are these digital investment platforms becoming more popular, but, the amount of money people are entrusting to them is rising, along with the types of robo advisors. Although robo advisors are democratizing investment advice and offer advantages, they may not be right for everyone, so it's important to understand all the factors that go into choosing one.
To find out if venturing into this kind of investment platform is right for you, it’s important to know some basics about robo advisors and ask yourself what will best help you achieve your financial goals.
Why Should I Consider Using a Robo Advisor?
Zero or low fees and balance minimums can help you meet your financial goals, and getting started is fast and easy.
Traditional portfolio management services typically require high balances, but robo-advisors usually have low or no minimum requirement. This offers a fast, easy entree into investing—it could take a matter of minutes without ever leaving your home.
Taking the human financial advisor out of portfolio management and letting software do the job lets robo-advisors charge lower fees, and over time, this can add up to higher returns for investors. Consumers are no longer limited to two extremes—paying a fee to a financial advisor to create and manage a portfolio, or going it alone with a do-it-yourself approach to picking investments.
How Do Robo Advisors Work?
Online advisors create and manage your investment portfolio by using computer algorithms and advanced software.
Before you commit to investing with one, you typically start with telling the robo advisor about yourself and your goals. An online questionnaire will ask your age, gross income, and if you are saving for retirement or something else, such as a new home, home improvement, a car, a wedding, a child’s education, travel or another goal.
You’ll answer questions about whether you’re looking to achieve the goal in the near term of a year or two, the short term of up to 5 years, or longer-term.
The robo advisor will assess what type of risk taker you are by asking questions such as whether you’re looking for higher returns with greater short-term price fluctuations and potential for loss, or how much you want to minimize the possibility of loss while sacrificing higher long-term returns.
Most robo advisors focus on low-cost exchange-traded funds or, ETFs, which also allow for good diversification in small portfolios.
In general, the annual management fees are low—0.25% and 0.50%, and some charge nothing.
Are You a New or Young Investor, or Have Low Net Worth?
If you are new to investing or don’t have much to invest, robo advisors can be a great option. With no minimum required to invest and low-cost, or no fees, it’s a great way to get started.
The goal-based investment strategies make it easy to design a portfolio, whether you’re a teenager saving to buy your first car or nearing retirement and optimizing your planning for that. Some robo advisors include career counseling, free checking and budget tracking to help you stay focused on your investment goal.
If you need or want, you can start out with actual small change and see where it takes you. Some robo advisors let you link your credit or debit card or PayPal account to a micro-investing platform that rounds up purchases to the nearest dollar and invests the extra change.
Do You Prefer a DIY Approach?
You might want to start off with a more active approach, or, you may be ready to move on from letting the robo do the advising. If that's the case, you'll be happy to know that some online wealth management services let the investor drive. You can browse individual stocks on major exchanges and select your ETFs to fit your portfolio.
Retirees who are withdrawing from 401(k)s can take control of their investments by tapping into these kinds of robo advisor platforms.
Do You Like the Efficiency of Automated Services? Or Do You Prefer Help From a Human?
If you're someone who likes the advantages of strictly automated investing, fantastic! Or, you may be the type of person who is averse to completely automated robo-advisors and would prefer a real person to interact with. If that's the case, there are robo advisors out there that also offer assistance from a person, with advisors available for questions.
Removing the human from the scenario can make it less intimidating for some, while hybrid models with access to advisors can ease trepidations for others, whether it’s via chat, or a premium level of service with a certified financial planner.
What Other Benefits Do Robo Advisors Offer?
Socially Responsible Investing
Many robo advisors offer portfolios composed of ETFs, which reduce exposure to companies with irresponsible environmental, social or governmental practices. Instead, they focus on companies that work to remedy such problems. Each company’s profitability is judged equally as much as its values and sustainable practices.
Some robo software can automatically adjust your investments so that they stay allocated according to your goal and risk preferences.
To offset gains in some securities and help cut your tax bill, some robo advisors can keep track of this and sell certain securities at a loss for you.
Premium services offered through robo advisors give you access to certified financial planners and executive coaches who can offer guidance such as salary negotiation advice—but at double the management fees.
Are There Disadvantages?
Robo advisors are relatively new and haven't been through a bear market in stocks yet. Some speculate about how the tools will perform in a downturn and their value if they almost exclusively track ETFs. Others say a bear market would highlight the advantages of robo advisors’ low-cost investment management. High fees aren’t noticed as much in bear markets, but paying 1% to 2% to lose money might not be tolerated.
Robo advisors, though, like people, have varying strengths and weaknesses. Some may offer better customer service and easy account setup, while others have lower fees, include educational tips and a focus on goal planning. Clearly, robo advisors can make it easier for just about anyone to get started investing and devising a path to meeting their financial goals.