Traditionally, average investors and families who wanted to grow their nest eggs faced a challenge when it came to getting financial help. Old-school advisors required a family to bring them $250,000, $500,000, or even a million dollars of money to invest before they’d accept the family as a client. For normal folks who are getting married and raising families, that’s an outrageous amount of money to have lying around.
That left a lot of people on their own when it came to figuring out their investments. Thankfully, the financial planning industry is changing. Families can now find fee-only financial planners who don’t require a minimum amount of assets to manage and instead focus on comprehensive planning as a primary service.
That’s one solution to the old-school financial advisor. Another solution that many people now use is the robo-advisor.
What Is a Robo-Advisor?
Robo-advisors are online platforms that allow people to open a brokerage account, transfer over cash, and allocate that money in different investments according to algorithms. Companies like Betterment, Wealthfront, and Personal Capital are all robo-advisors. They perform the same basic function and offer a few unique features each.
The idea was to make investment more automated and easier to access for the average person, removing the need for human money managers acting as middlemen between investors and the markets. The algorithms that decide your asset allocation are based on Modern Portfolio Theory and the Efficient Market Hypothesis.
You also fill out a questionnaire to help the robos understand your risk tolerance, financial situation, and general goals, which all impact your asset allocation.
Robo-advisors do offer some benefits. You can sign up for a brokerage account and start investing quickly, creating a profile in about 5 minutes or less. You don’t need much money to get started. Vanguard is known for its low fees and low minimums, but you need at least $1,000 to open a target date retirement fund with them. Most other accounts require at least $3,000.
The more time you give your money to grow in an investment account, the more likely you are to benefit from compounding returns.
Downsides of Robo-Advisors
That’s not to say robo-advisors don’t come with downsides. Here are a few things to know before you open an account on a robo platform:
- Robos aren’t necessarily cheap investment managers. Many advisors charge around 1% of a client’s portfolio, which compares to the fees many robos charge. Consider the other downsides below, and any cost savings might not be worth it due to the value you lose out on by not working with a trained professional who knows you personally.
- Robos are risky, too. Robo advisors are based on algorithms, but that doesn’t mean they’re infallible. Every investment comes with risk, even if it’s automated by a completely rational robot.
- They’re not a replacement for a financial planner. A good fee-only financial planner looks at all aspects of your situation and considers your values and goals to help you make the best decisions possible when it comes to your money. A robo advisor doesn’t know you personally and certainly doesn’t understand more than what the data shows.
Pros and Cons: Where Are We?
There are benefits to using a robo-advisor as your sole method of portfolio management, but there are things a robo-advisor simply can’t do. While a robo can help you start investing, they can’t sit down and have a conversation with you when markets get volatile and you get nervous.
They can’t help you make the absolute best financial decision for you because they don’t understand your very human goals and the values that drive those. Robo-advisors can’t talk through difficult, emotional, and complicated choices with how to use your money. They can’t show you all the available paths for your family and give you the information you need to make a decision about which of many reasonable options you should choose.
The Real Value of a Human Advisor
The biggest value of professional financial planning may not be in telling you what to do with your money. Often, the greatest value of an actual person helping with your financial planning needs is when they tell you not to do something. Carl Richards talks about this in his book, The One Page Financial Plan. He says a real financial advisor can stand between you and the “Big Mistake” of investing in a way that causes you to buy high and sell low. Understanding how behavioral investing impacts your goals highlights why human judgment matters so much.
A robo-advisor can’t stop you from doing that. It can give you a lot of data and information and charts, but it can’t have a human conversation with you. Without tailored, one-on-one guidance, mistakes that cost you dearly are more prone to happen.
A lack of information is not the problem. It’s our behaviors and habits that can get us into trouble. A robo-advisor can help you start investing. But eventually, as your financial situation becomes more complicated and you have hard decisions to make, you could benefit from bringing on a fiduciary financial planner to work with you to grow your wealth. Learning how to choose a financial planner ensures you find an advisor who understands both the numbers and the human side of financial planning.
The Best of Both Worlds
The speed and convenience of the technology that comes with a robo-advisor platform combined with the holistic, person-centered planning and investment strategies that a human investment advisor provides can offer clients the complete package. This hybrid creates an advisor that will speak to the needs and wants of today’s client.
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