Robo-advisors first made their appearance in 2008 and have quickly become a popular financial tool, especially for younger investors. And today, it seems that just about every brokerage firm is offering its own robo-advisory services.
Before jumping into using a robo-advisor, it’s important to take a step back and determine whether it’s really the right choice for you. While they have plenty of benefits and are a great choice for certain investors, there are alternatives to consider and may not be right for everyone.
How Robo-Advisors Work
A robo-advisor is an automated investing service that uses a computer algorithm to build an investment portfolio for its users. Customers answer questions about their financial goals, risk tolerance, time horizon, and more, and then the robo-advisor chooses suitable investments.
Robo-advisors are a type of passive investing, and they typically choose assets well-suited to a buy-and-hold investment strategy. They typically build portfolios with ETFs or index funds rather than individual stocks.
Pros and Cons of Using a Robo-Advisor
Robo-advisors have become increasingly popular over the past decade, and for many good reasons. But there are also some downsides to using a robo-advisor instead of the other alternatives. It’s important that you understand the pros and cons upfront.
- Lower fees than traditional advisors: While many financial advisors have fees of 1.0% or more of assets under management, a common robo-advisor fee is about 0.25%.
- Accessible for new investors: Robo-advisors can be a first step into the investment world for new investors or those who don’t feel comfortable choosing investments on their own.
- Low investment minimums: While many traditional brokerage firms and financial advisors require a minimum balance to start investing, robo-advisors allow you to start investing with any amount.
- Automatic tax-loss harvesting and rebalancing: Robo-advisors automatically rebalance your portfolio and do tax-loss harvesting, so you don’t have to worry about it.
- Limited investment options: You sometimes can’t select individual investments with your robo-advisor account. If you want to buy a particular stock, you may have to open a second brokerage account with another firm.
- Higher fees than DIY investing: While robo-advisors may have lower fees than traditional financial advisors, they have higher fees than if you manage your own investment account.
- Less targeted investment strategy: Your robo-advisor builds your portfolio based on your financial goals, but it’s not as targeted as it would be with a financial advisor choosing investments perfectly suited to your situation.
- No hands-on help available: Even with a robo-advisor choosing your investments, you may still have questions about your portfolio or other parts of your finances. With a robo-advisor, there’s no one to direct those questions to.
Robo-Advisor Fees vs. Other Options
One of the first things people think about when seeking help with their investments is how much it will cost. And it’s true, having someone else manage your investments — whether it’s a person or a computer algorithm — comes at a cost. Let’s explore the fees associated with your different portfolio management options:
- DIY investing: Managing your own portfolio has the lowest costs associated with it. The only fee you’ll pay is the fee associated with each individual investment. In the case of index funds and mutual funds, these are known as expense ratios.
- Robo-advisor: When you invest with a robo-advisor, you’ll still be on the hook for the expense ratios for your individual investments. You’ll also pay the robo-advisor’s management fee, which is often around 0.25%.
- Financial advisor: Hiring a financial advisor to manage your portfolio is often the most expensive option. You still pay the expense ratios associated with any funds you’re invested in. Financial advisors also charge management fees that often equal 1-2% of the assets under management.
Personal Capital’s fee-based investment services range from 0.49%-0.89%. You have access to a fiduciary financial advisor who can help guide you through important financial decisions, even beyond your investments.
Robo-Advisor vs. Financial Advisor
As you look for help managing your investments, you might be weighing the options between a robo-advisor and a financial advisor.
The benefit of a robo-advisor comes down to two factors: cost and accessibility.
First, robo-advisors have fees that are roughly a quarter of what you can expect to pay with a financial advisor. And for someone with relatively basic investing needs, the savings can definitely be worth it.
Robo-advisors also rarely have large investment minimums. On the other hand, many financial advisors require $100,000 or more of assets under management.
But it’s also important to note where robo-advisors fall short. While robo-advisors can choose investments that are appropriate to your financial goals, they can’t provide personalized advice, hands-on support, or help with other areas of your financial life.
Robo-Advisor vs. DIY Investing
Some investors choose not to enlist the help of a robo-advisor or financial advisor to manage their portfolios and instead take on the job themselves.
Going the DIY route has some obvious advantages. You avoid the management fee that comes with hiring outside help. You also have complete control when it comes to choosing your investments.
But managing your own portfolio has its downsides as well. In some cases, you could actually end up with a more expensive portfolio if you don’t think to pay attention to your expense ratios.
Choosing your own investments also requires a significant amount of research and time. There’s a seemingly endless number of investments to choose from when you consider individual stocks and bonds, index funds, mutual funds, ETFs, and more. Without really understanding the purpose of each type of security in your portfolio, it can be easy to get overwhelmed and choose investments that won’t really get you to your goal.
Can Robo-Advisors Replace Traditional Advisors?
The world of finance is changing rapidly thanks to technology, and some people might find themselves wondering if robo-advisors can or will replace traditional financial advisors altogether.
Yes, a robo-advisor can choose investment on your behalf to help you meet your financial goals. But it’s also important to remember that choosing investments is just one small part of what a financial advisor does.
Other services that financial advisors often provide include:
- Helping you identify financial goals
- Investment planning
- Tax optimization
- Estate planning
- Help through major life changes
- Insurance planning
- Financial advice
- Overall financial planning
While robo-advisors can effectively do one of the tasks that financial advisors do, they simply don’t provide the same well-rounded financial support.
Who Should Use a Robo-Advisor?
We’ve talked about the pros and cons of robo-advisors and how they compare to other investment management options. But how do you decide which is right for you?
In general, a robo-advisor might be the right choice for someone in the following situations:
- You’re just getting started with investing
- You don’t have a lot of money to invest
- You don’t want to choose your own investments
- You don’t have a complex financial situation
- You prefer to use digital tools rather than working with a person
- You don’t need other financial planning services
The Bottom Line
A robo-advisor can be an affordable and accessible way to start investing for your future. And while they come with plenty of benefits, they may not be the best long-term strategy, and can’t provide holistic financial planning services. Instead, they’re a great entry point into the market before you eventually enlist the help of a financial advisor.
If you’re considering hiring a financial advisor, learn more about Personal Capital’s wealth management services, which give you access to licensed fiduciary advisors to guide you along each step of your financial journey.
Personal Capital compensates Erin Gobler (“Author”) for providing the content contained in this blog post. Compensation not to exceed $500. Author is not a client of Personal Capital Advisors Corporation. The content contained in this blog post is intended for general informational purposes only and is not meant to constitute legal, tax, accounting or investment advice. You should consult a qualified legal or tax professional regarding your specific situation. Keep in mind that investing involves risk. The value of your investment will fluctuate over time and you may gain or lose money. Any reference to the advisory services refers to Personal Capital Advisors Corporation, a subsidiary of Personal Capital. Personal Capital Advisors Corporation is an investment adviser registered with the Securities and Exchange Commission (SEC). Registration does not imply a certain level of skill or training nor does it imply endorsement by the SEC.