Is a robo-adviser right for you? The answer to this question boils down to your unique needs, complexities and personal preferences.
What Is a Robo-Adviser? The Answer Lies Between the Lines
You can Google “robo-adviser” and find thousands of definitions. Put simply, they are a cost-effective solution that sits between managing your own investments and hiring a full-service wealth management firm to manage your entire financial picture. The hierarchy looks something like this:
- Do-It-Yourself (DIY) Investing
- Full-Service Wealth Manager
Need a little more clarification? LegalZoom can serve as a helpful analogy. Their online templates may cost more than drafting a legal document on your own, but they’ll save you time and likely produce a better deliverable. LegalZoom also costs less than retaining a full-service law firm, but their easy-to-edit templates may fall short if the complexity of your legal situation requires a specialized attorney. The hierarchy for legal services here would look like this:
- Do-It-Yourself (DIY) Legal Work
- Professional Attorney
The same can be said about robo-advisers. A full-service wealth manager can be worth every penny if you have complex needs, or you simply prefer to spend your valuable time doing something else. If not, most robo-advisers seem appropriately priced for the mid-range investment services they offer.
What Will a Robo-Adviser Do for You?
Services vary, but in general, a robo-adviser should:
- Collect basic information, like your financial goals, risk tolerance and timeline.
- Use its proprietary algorithm to recommend a model investment portfolio for you.
- Offer an online platform for you to fund your account through a money transfer, an upfront deposit and/or recurring deposits.
- Allocate your assets into the model portfolio you’ve selected.
- Manage your model-based portfolio moving forward, including periodic rebalancing.
Some robo-advisers also offer online budgeting and financial planning, as well as access to a human adviser — usually for an additional cost. As robo-advisers continue to evolve, the lines may blur between their “robo-” and “adviser” roles, but it’s unlikely their personalized interactions — or pricing — will approach the levels you’d expect from a dedicated adviser.
With that being said, Alex Lynch, CFA, a Wealth Adviser at Jarvis Financial, believes that robo-advisers could eventually prove to be a good solution to improving financial literacy and education in America.
“Approximately 67% of Americans do not have a written financial plan. If robo-advisers can continue to evolve past providing generic investment allocation advice, they could really move the needle and help more households gain access to financial planning services at a palatable cost,” says Alex.
Newish Name, Oldish Idea
However we define them, robo-advisers have been on the rise lately. These days, there are close to 100 of them across 15 countries, and growing. Some are new firms like Wealthfront and Betterment, whose founders were leaders in popularizing the robo-adviser model. Others are familiar names that jumped on the existing bandwagon, such as the Schwab Intelligent Portfolios, Fidelity Go® and Vanguard Personal Adviser Services.
Robo-advisers aren’t as new as you might think, by the way. While the term didn’t take off until around 2012, it made at least one early appearance nearly 20 years ago, in a Financial Planning piece titled “Robo-Adviser: In a new world of intense 401(k) anxiety brought about by the Enron fiasco, the only hand investors may have to hold may be digital.”
Plus, I’d argue the robo-adviser concept has been around even longer — since the Vanguard Wellington fund was born back in 1928. This balanced U.S. mutual fund offered investors turnkey access to a one-stop, low-cost, diversified portfolio of stocks and bonds, governed by a prospectus prescribing its investment strategy and target risk levels.
That’s essentially what a robo-adviser offers too: turnkey access to low-cost, automated investing using a rules-based approach. In that context, there’s nothing dramatically new about the financial industry offering various levels of thriftier/cookie-cutter versus costlier/tailored investment solutions.
Variations on the Theme of Robo-Adviser
Which brings me to my next point: You don’t always have to transfer all your money to a robo-adviser to obtain a mid-price, mid-service solution for automated investment management services. Most major mutual fund companies offer low-cost, balanced mutual funds that automatically manage your money based on your desired goal and risk level. For example, a low-cost target date fund would meet this criteria.
There are some caveats: A traditional balanced fund may not be built from the ground up using the latest technology, generously funded by venture capital. They may not always be as effectively diversified as their name suggests. And not all of them are low-cost.
That said, robo-advisers often come with their own challenges, too.
- Administrative hurdles: We’ve seen evidence that it’s easier to join a robo-adviser platform than to leave it. Some of them insist on cutting a physical check instead of facilitating electronic transfers when you go. And at least one well-known robo-adviser, financial advisers have encountered problems transferring essential cost-basis information.
- Future unknowns: The robo-adviser industry is also relatively new and competitive, with independent firms being launched, merged, acquired by bigger players, and taken public in the blink of an eye. In other words, the platform you begin with may not be the platform you remain on over time.
- Opaque costs: Last but not least, some robo-advisers advertise implausibly low prices. They then may make up for seemingly “free” trades by using proprietary funds with higher underlying expense ratios, or by requiring large cash positions, so they can make their profit from behind-the-scenes lending strategies. Suffice it to say, when a price seems too good to be true, it probably is, and at least one well-known robo-adviser is being accused of violating its fiduciary duty due to some of these actions.
That’s not to say a robo-adviser may still not be a good deal, and a sensible “in-between” solution for you. But you’ll want to dig deeper to find out. And remember, robo-advisers aren’t the only mid-range game in town. No matter what you’re considering, shop around, and read the fine print. It might even be worth consulting with an independent financial planner to obtain a second opinion before you proceed.
Are You Ready to Robo?
So, when is a robo-adviser or similar solution right for you? Assuming you usually get what you pay for, robo-advisers make sense when you’d like to have your investments managed efficiently and cost-effectively. In fact, they may be more accurately called robo-managers. Their strong suit is doing the investment management when your top priority is to make and save money, and your financial-and tax-planning needs are relatively straightforward.
A good robo-adviser can also help do-it-yourself investors avoid falling into the most common financial behavioral traps that so often ensnare them. Plus, they can free more of your time to pursue your actual life’s interests, instead of fussing with your portfolio or worrying about the daily movements of the financial markets.
The Worth of a Financial Planner
For the simple, cost-effective purposes just described, robo-advisers are often priced appropriately. If, however, you want or need high-touch, human interaction and tailored advice, you’re likely to be left wanting more than a robo-adviser has to give. They can be too automated when years of accumulated wealth may benefit from far more nuanced management.
For example, a more sizable investment portfolio with larger positions and embedded taxable gains may need to be carefully handled as part of a diversified portfolio, rather than auto-traded by an algorithm. Plus, as you approach and enter retirement, you’re likely to have planning needs that go beyond simply saving and investing. These may include creating a tax-efficient income stream; coordinating insurance, estate planning and charitable goals; and more.
Over time, you may also increasingly value having a dedicated adviser to facilitate and hold you accountable to your financial goals. Even if you turn to a robo-adviser/planner pair, it won’t always measure up to real financial advice. How comprehensive or personalized can someone be if you’re one among 1,000+ clients assigned to them?
A big sign indicating that it might be time for more personalized advice is when you start asking yourself more complex questions about your money, like:
- What should I do with my stock options?
- Can I retire in 10 years, rent out my house, and travel the world?
- How can I reduce my tax bill?
You know they’re important questions, you don’t have the answers, and you wouldn’t mind hiring someone to help you resolve them. Especially if your accumulated wealth has started keeping you up at night instead of helping you sleep more soundly, it’s probably time to de-automate your planning.
Founder and CEO, Define Financial
Taylor Schulte, CFP®, is founder and CEO of Define Financial, a fee-only wealth management firm in San Diego. In addition, Schulte hosts The Stay Wealthy Retirement Podcast, teaching people how to reduce taxes, invest smarter, and make work optional. He has been recognized as a top 40 Under 40 adviser by InvestmentNews and one of the top 100 most influential advisers by Investopedia.