Robo advisors are the latest innovation in online investing these days. They can eliminate much of the trouble and cost from managing your investments by replacing the human financial advisor.
However, should you completely trust your hard-earned money to a robot? To answer that, we will have to take a closer look to see if a robo advisor is right for you.
What is a Robo-advisor?
Robo advisors are online software that helps investors manage their investments. They are digital platforms that offer automated, algorithm-driven financial planning services.
They use complex computer algorithms to buy and sell investments, as well as rebalance an investment portfolio according to the investor’s needs and risk tolerance. Robo advisors may also include human advisors, but only for services that need human assistance, such as taxes, retirement, and estate planning.
Standard robo advisor gathers information from clients, such as their financial state and future goals by asking a series of questions online, which it will use to provide advice, or automatically invest client’s assets. Most of them use mutual funds, or exchange-traded funds (ETFs) to create the portfolio.
There are more than 200 robo advisors available in the US so far and new ones are coming in every year. All of them offer a certain combination of investment management, retirement planning, and financial advice.
Who can best use it?
Robo advisors usually works best for starting investors, who want to set their portfolio on automatic and for investors that have quite a simple situation.
These digital platforms are a great solution for someone who is tech-dependent and is still building enough investible assets to hire a human advisor. They are also good tools for a do-it-yourself investor who no longer wants to choose investments, rebalance, and place trades on their accounts.
However, investors with stock options, or need to coordinate 401(k)s with other accounts, or who is looking for a more personalized approach to the tax impact of investing, then an automated solution may not be the right choice.
The Pros and Cons of Using a Robo advisor
Various robo-financial advisors have their own approach to the service. While they definitely have their advantages, they might not be for everyone.
There is something to be said for a 100 percent algorithm-driven investment approach. Even if it might help with a certain number of investors, there are always some situations where automated guidance is not suitable.
Consider these advantages and disadvantages before deciding to hand over your money to a robo advisor.
Robo advisors are capable of providing investment advice usually offered by a human advisor for a fraction of the price.
Most robo advisors charge annual flat fee of 0.2 percent to 0.5 percent of the client’s total account balance. Additional fees may apply if the amount of the portfolio is lower than the specific threshold.
Human financial advisors usually charge a rate of 1 percent to 2 percent and maybe more for commission-based accounts.
However, keep in mind that robo advisor fees are only for their services. It does not include the fees on ETFs they buy on the investor’s behalf.
Most robo advisors’ algorithms rely on Nobel Prize-winning investment theory to guide their products.
The best applied investment theory tries to build an investment portfolio that will provide the biggest return with the smallest risk.
The robots used advanced investment portfolio research learned by award-winning personalities to run their models.
Robo advisors require less capital to get started. Usually the minimum assets needed to register for an account are in the hundreds to thousands, but some robo advisors are accessible with $1,000 to $5,000 to get started, while others offer no account minimum at all.
Robos with high-access requirements are also more accessible than financial advisors with $1 million portfolio minimums.
Human advisors on the other hand, do not typically see to clients with less than $100,000 in assets. They prefer high-net-worth clients, who needs various wealth management services and are capable of paying for them.
Once an account is created, the robo advisor automates the whole process. Investors no longer have to worry if they need to make adjustments to their portfolio, or speculate if they should invest more in technology or less in financials.
Investors also do not have to be concerned if a broker is offering a recommendation that would not benefit him.
Robo advisors are accessible 24/7, provided that the user has an internet connection.
Avoid Investing Errors
Using robo-advisors can help investors avoid making costly investing mistakes. It has been recognized that one of the major reasons why investors get poor results is because of their own actions.
Investors at times make emotional decisions during market highs and lows, and based on their own instincts. Software however, does not make these types of errors.
Robo advisors can be more objective and are not tempted by commissions or incentives to put one investment forward over another.
Robo advisors also keep things simple, which may work well with young investors, who do not have a lot of assets yet.
If an investor’s tax situation is not too complicated, or there is no need for estate planning services yet, an online investment manager could be a good choice.
Another reason to choose a robo advisor is the level of convenience it provides. Investors who do not have time to actively supervise their investments can use this service to lessen some of the task that they have to do.
While several robo advisors let an investor to set and revise his goals through their financial planning software, he also has money-related concerns that can be only be addressed by talking with a human advisor.
Most of these digital platforms will not be able to put an investor’s mind at ease after a sharp market drop.
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Human financial advisors can relieve investor’s worries and tell how the investment markets work. They work to integrate investors’ finances, taxes, and estate goals.
Selling call options on an existing portfolio and buying individual stocks are also out of a robo advisor’s expertise. There are successful investment strategies that surpass an investing algorithm.
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Some new investors might also prefer a wider portfolio with a broader range of asset classes than the usual robo advisors offer.
Can’t Meet In-Person
If the investor wants a personal and in-person relationship with his financial advisor, then a robo advisor is not for him.
These robots do not have a physical workplace, where a client can have a one-on-one discussion with an advisor. This kind of contact can only be done with traditional advisors.
Some robo advisors are able to offer live assistance, though this will be a bit more costly. Others can work together with the investor almost exclusively through the web.
Saving for Retirement
Robo advisors are beneficial for some investors. Still, there are situations where it is better to ask the help of a human advisor.
For example, if an individual is saving for retirement, a human financial advisor might be able to take his situation into account and help develop plans to achieve his goals. A financial advisor could also offer a more detailed advice about budgeting, career changes, and when to retire.
Moreover, financial advisors may be able to help with financial concerns outside of the investing area. If the client is trying to pay down debt or saving for future plans, a financial advisor can suggest on what steps to perform so he can build up the necessary funds at his chosen pace.
Robo advisors might be unable to consider those things when they are creating the client’s investment strategy.
It is a fact that robo advisors offer their services for a lot less money, but not all. The same goes for human advisors as well. There are financial advisors, who charge about 1.0 percent of assets under management (AUM) for their services.
Some advisors charge an hourly rate or fee for service, allowing their customers to control costs, while they get personalized information. There are also advisors, who use robo advisors and combine them with their own services, thus reducing fees and charges.
Robo advisors are not financial planners. Some have software tools that can help plan how an individual’s account will grow.
The downside though, is the client does not receive personalized planning advice about how much to save, whether to use Roth IRA or traditional IRA, and how to allocate investments in other accounts, such as his 401(k).
If an individual is near retirement, the allocation models used by a robo advisor might not help support the investments for the withdrawal process. For this reason, it is better to ask the help of a financial advisor.
The world of robo advisory has just started. They have helped investors by reducing fees, while offering several ways to professional asset management.
Robo advisors differ from investor to investor. Younger investors, who are looking for low fees, could be best assisted by a robo advisor.
Just like with any life decision, investors should determine what kind of investment assistance he needs, and choose either a robo advisor or a financial advisor to match their own style.
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