Robo-advisors are a fairly new financial services offering. They allow you to turn over your money to an automated advisor. Most robo-advisors offer:
- Asset allocation of your stocks, bond, and other investments. This is done in line with your risk level.
- Automated rebalancing.
- Tax-loss harvesting for taxable accounts.
- Educational investment tools, such as retirement planning.
Robo-advisors, including Wealthfront and Betterment, aim to take on traditional financial advisors. So how do they stack up?
- Robo-advisors use automation and software algorithms to help you invest your money according to your goals.
- Typically, robo-advisors cost less than financial advisors and are able to match market returns.
- However, financial advisors are better at creating comprehensive plans for your money and choosing specific assets.
Where Do Robo-Advisors Shine?
There are areas where a robot is a far better money manager than either a DIYer or a financial advisor. In this case, the robot is a money management platform backed by a sophisticated algorithm.
Here's where robo-advisors come out on top.
Fees and Minimums
Most financial advisors charge around 1% of AUM (assets under management) to handle your investment portfolio. In contrast, robo-advisors’ fees range from zero for Schwab Intelligent Portfolios, to 0.89% for benefit-rich Personal Capital.
Also, many advisors will require clients to have a large minimum account balance; in contrast, Wealthfront will let you in the door with just $500. Betterment, on the other hand, has no minimum to open an account.
Research suggests that rebalancing your portfolio back to its preferred asset allocation from time to time improves returns; it can also reduce volatility. Rebalancing is a strategy to keep your investments in stocks, bonds, and other funds constant and in line with your preferences.
You can do this on your own. Or, you can have your investment advisor perform this task. But a robo-advisor does a great job of automating this task.
Matching Market Returns of Their Benchmarks
Market-matching returns don’t sound glamorous. But most active mutual funds fail to meet those metrics. Vanguard and countless academics have compared the returns of active fund managers with the market indexes.
They’ve found that most active fund managers fail to beat the market indexes. Those that manage to outperform one year rarely continue their market-beating returns.
What Robo-Advisors Can’t Do (Most of the Time)
Robo-advisors have many advantages. But there are some tasks best left to a human. This is even more true if you’re very wealthy and/or have complicated needs.
Here’s where robo-advisors fall short (most of the time).
Creating a Comprehensive Financial Plan
If you have a high six- or seven-figure net worth, a robo-advisor may not be be enough for you. You’ll need a trusted advisor who can examine your entire financial picture. This should include estate, tax, trusts, and life insurance considerations. A full-service financial advisor might be best for your broad economic concerns.
Some robo-advisors, like Betterment, do offer some human assistance. But their offerings will likely fall short of the hands-on, holistic approach of financial planning practice.
Choosing Specific Financial Assets
A robo-advisor may not work if you want to invest in peer-to-peer lending, master limited partnerships, closed-end funds, individual stock, bonds, currencies, options, and more. Most robo-advisors are limited in their types of available investments. In fact, there aren’t many robo-advisors that provide access to more than 12 to 25 funds.
What if you’re an active stock picker and want to work with a financial advisor in an effort to outperform the markets? A robo-advisor isn’t right for you. Most tools aren’t flexible enough for those who want to pick their own assets.
That said, there are a few robo-like advisors with a bit more flexibility, such as M1 Finance. And traditional brokerages like Charles Schwab have begun offering automated services. These allow account holders to use a robo-advisor. At the same time, they can take advantage of the more traditional investments offered by a brokerage.
Beat the Market
Most robo-advisors follow an index fund investing strategy. That means that they’ll closely match market performance; however, they won’t beat it. Some services, including Betterment’s Smart Beta strategies, have unique strategies. They attempt to beat the market. But the results are still out on the performance results.
A sophisticated algorithm or not, your robo-advisor probably won’t be able to beat the stock market. But then again...neither will your human advisor.