Robo advisors are a relatively new financial services offering that lets you turn over your money to an automated advisor. Here’s what most robo advisors offer:
- Asset allocation of your stock, bond, and other investments, in line with your risk level
- Automated rebalancing
- Tax-loss harvesting for taxable accounts
- Educational investment tools including retirement and education planning
Robo advisors, including Wealthfront and Betterment, aim to take on traditional financial advisors. So how do they stack up?
Where Robo Advisors Shine
There are areas where a robot—or, more accurately, a money management platform backed by a sophisticated algorithm—is a far better money manager than either a DIYer or a financial advisor.
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.
Additionally, many advisors will require clients to have a large minimum account balance; in contrast, Wealthfront will let you in the door with just $500, and Betterment has no minimum to open an account.
The research suggests that rebalancing your investment portfolio back to its preferred asset allocation periodically improves returns and reduces volatility. Rebalancing is a strategy to keep your percentage invested in stocks, bonds, and other funds constant and in line with your preferences.
You can do this on your own or have your investment advisor perform this task, but a robo advisor does a great job of automating this tedious investment task.
Matching Market Returns of Their Benchmarks
Although market-matching returns don’t sound glamorous, 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, and those who manage to outperform one year rarely continue their market-beating returns.
What Robo Advisors Can’t Do (Most of the Time)
Despite robo advisors’ advantages, there are some tasks best left to a human, especially if you’re very wealthy and/or have complicated financial needs.
Here’s where robo advisors fall short (most of the time).
Create a Comprehensive Financial Plan
If you have a high six- or seven-figure net worth, a robo advisor likely won’t be enough for you. You’ll need a trusted financial advisor who can examine your entire financial picture, including estate, tax, trusts, and life insurance considerations. A full-service financial advisor with a stable of related advisors 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.
Choose Specific Financial Assets
If you want to invest in peer-to-peer lending, master limited partnerships, closed-end funds, individual stock, bonds, currencies, options, and more, a robo advisor won’t work. 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.
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 for you. Most automated tools aren’t flexible enough for investors who want to pick their own assets.
That said, there are a few robo-like investment advisors with a bit more investment flexibility, such as M1 Finance. And traditional brokerages like Charles Schwab have begun offering automated advisor services, allowing account holders to use a robo advisor while also taking advantage of the more traditional investments offered by a brokerage.
Beat the Market
Most robo advisors follow an index fund investing strategy, meaning that they’ll closely match market performance—but they won’t beat it. Some services, including Betterment’s Smart Beta strategies, have unique strategies that attempt to beat the market. But the performance results are still out.
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.
Barbara A. Friedberg is a former portfolio manager and author of Invest and Beat the Pros-Create and Manage a Successful Investment Portfolio. Her writing appears on various websites including Robo-Advisor Pros.com and Barbara Friedberg Personal Finance.com.