What Is a Robo-Advisor?
When you’re just getting started, all of the choices involved with investing can be overwhelming. One of the first and most important decisions that you will need to make is the type of financial advisor you need and want to help you manage your investment portfolio. By learning about the different options and the pros and cons associated with each, you can make sure that you’re making the right decision for you and your financial future.
What Are Robo Advisors?
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Robo-advisors are online financial advisors that rely on technology and algorithms to help manage users’ money and financial plans. Though traditional financial advisors also use technology to manage investments for their clients, robo-advisor platforms create and deliver financial advice directly through technology with next to no human supervision.
How Do Robo-Advisors Work?
Robo-advisors can have slight variations in how they function depending on the platform you’re looking at. In most cases, they operate by:
- Having users fill out a survey. Sometimes referred to as online advisors or automated investing services, robo-advisors usually collect key information from their clients, such as their current financial situation and goals, through an online survey. This questionnaire is designed to evaluate the individual’s investment needs and risk tolerance.
- Building a diversified investment portfolio. The system then uses advanced software and algorithms to process the data from the surveys, provide financial advice, and invest a client’s assets automatically. Most of this is done without any human interaction, but some platforms have human advisors available to address any questions or concerns from users.
- Monitoring the account activity. Platforms track the underlying investments and overall market activity using an algorithm. If things change, this same algorithm makes adjustments in the portfolio to keep it balanced.
Most of the current robo-advisors employ passive indexing strategies that rely on some form of modern portfolio theory, or MPT.
How Much Robo-Advisors Cost
Because everything is automated, robo-advisors cost significantly less than their traditional, human counterparts. Just like with a normal financial advisor, the associated fees are typically based on a percentage of the assets being managed by the robo-advisor. A majority of these platforms charge an annual management fee that’s somewhere between 0.25% and 0.50%, but there are some free alternatives available as well. This fee is usually calculated based on your account, prorated, and then paid on a monthly or quarterly basis.
Standard brokerage accounts charge a commission for handling various transactions. Though there are almost always management fees, robo-advisors generally don’t charge these transaction fees. Robo-advisors also differ from standard brokerage firms because their minimum balance requirement is usually either very low or non-existent.
Services Robo-Advisors Offer
Every online investment platform is slightly different, but most robo-advisors offer things like:
- Tax-strategy services, like tax-loss harvesting, for taxable accounts.
- Tools for financial planning, such as retirement calculators.
- Portfolio rebalancing, either done at set intervals or automatically.
How to Decide if a Robo-Advisor Is Right for You
If you’re contemplating whether to use a robo-advisor, you should first consider the:
- Type of investment account. Most robo-advisors exclusively manage taxable accounts and individual retirement accounts. There are a few options out there that will help you manage trusts or your 401(k) as well. Depending on the type of investment account you need, you may need to rely on the individualized attention of a personal financial advisor.
- Minimum requirements for investment. There are certainly options that require a modest account balance of $500 or less, but there are also robo-advisors that require upwards of $10,000 to get started.
- Selection of assets. Robo-advisors build client portfolios using primarily low-cost index funds and exchange-traded funds, or ETFs. It’s important to keep in mind that when trading these types of funds, you’ll have to pay the applicable fees, known as expense ratios, on top of the platform’s management fee. If you’re hoping to invest in different kinds of assets, a robo-advisor may not be well-suited for you.
Pros and Cons of Using a Robo-Advisor
As with any financial decision, there are benefits and drawbacks associated with using a robo-advisor.
Pros of Using a Robo-Advisor
Some of the advantages of using an online advisor include that they are:
- Cost-efficient: Because robo-advisors eliminate the need for human labor, they are usually quite a bit cheaper than traditional advisors.
- Accessible: The only constraint for accessing an online trading account is your access to the internet, meaning users can log in 24/7. On top of that, online advisors typically require significantly less capital to start trading.
- Efficient: Executing trades requires little to no effort on your part since the software handles transactions automatically.
Cons of Using a Robo-Advisor
A few of the disadvantages of using a robo-advisor are due to the fact that they are unable to:
- Accommodate custom trades: In most cases, you can’t purchase individual bonds or stocks or decide which ETFs or mutual funds you’d like to invest in when using a robo-advisor.
- Handle complex services: Robo-advisors are better suited for entry-level investors that have small accounts. Those that require more advanced assistance, such as retirement planning, trust fund administration, complicated tax management, or estate planning, will find these platforms insufficient.
- Deal with the unexpected: Extraordinary situations, like receiving an inheritance after a loved one passes away, require delicate and customized management that robo-advisors are ill-equipped to handle.
- Help clients understand their financial circumstances and goals: Not every client has a deep understanding of their risk tolerance or even what that is, making the generalized questionnaires difficult to navigate. If you’re still trying to understand your financial standing and define your goals, having a personal financial advisor who can guide you and explain the implications of each choice can be invaluable.
Robo-advisors have many advantages, but whether using one is the right choice for you really depends on your unique needs and goals. At Hawaii Partners, we provide clients with the individualized attention and customized financial planning that they need to flourish. Contact us today and let’s start investing in your future.