Years ago, most of us got our financial advice from other people, typically traditional financial advisors. These advisors spent their careers providing advice to consumers about the best mix of stocks and bonds for their portfolios.
Today, there are still countless qualified brokers and advisors we can turn to, but many of us have taken a more active role in managing our own portfolios. At the same time, technology has changed the investing landscape, and a new type of financial advisor, a “robo-advisor” has entered the scene.
Robo-advisors can offer a number of benefits, but like any other financial service, they can also have drawbacks. If you’re considering getting started with one, here’s a look at everything you need to know so you can make an informed decision.
How Robo-Advisors Work
A robo-advisor is an app or a platform that gives automated, mathematically-derived financial planning advice with little human oversight. It works like this:
- Step One: You set up an investment account with a robo-advisor service.
- Step Two: You answer a series of questions about your goals, financial situation, and comfort with risk.
- Step Three: The robo-advisor buys and sells assets based on your answers, managing your portfolio automatically according to the paradigms you created.
- Step Four: Your portfolio grows (in theory), according to the algorithms of the robo-advisor and based on market conditions. You can also set up weekly or monthly automatic contributions from your bank account to the robo-advisor.
The Pros and Cons of Robo-Advisors
PRO: Low Cost
A robo-advisor does its work automatically, with little human intervention. That means there’s no broker fee to pay, which means these financial planning services come at a lower cost than traditional brokerages and financial advisors.
Although rates vary from service to service, robo-advisors charge between 0.25% and 0.35%, while the average rate for a human advisor is around 1%. As of this writing, robo-advisors favor low-cost index funds, which outperform other options substantially and are among the most cost-effective and safest investment options available.
CON: Not Too In-Depth
Although robo-advisors are inexpensive, they don’t provide the most in-depth advice. For example, a robo-advisor won’t be able to help you with estate planning questions, or bigger picture questions about the right mix of asset allocations for your individual situation. If you have specific questions about your broader financial situation, or an ever-changing financial picture, you may want to seek out a human advisor instead.
PRO: High Performance
As of January 2020, most robo-advisor apps use low-cost index funds, which outperform other options, often by a margin of as much as 90%. Until robo-advisors begin offering other products, that means they’re a reliable, profitable option — though they rarely see the skyrocketing potential of riskier buys.
CON: No Human Touch
Robo-advisors aren’t personally advising you. They’re making decisions about your money based on a brief survey that you’ll take, which is sufficient for many decisions… But there’s no person to sit with you to deeply understand the nuances of your financial situation. In other words, there’s no one there to answer the phone and offer reassuring words about the market-moving headlines you just read.
PRO: It’s Easy
Robo-advisors are pretty simple. For people who just want to save money without thinking about it, they can be just what the doctor ordered. After you fill out the initial intake forms, you can check your balance and performance as often or as infrequently as you like, with no obligation to take meetings or calls — these accounts are the very definition of “set it and forget it” once it’s synced to your bank account.
With that said, if you do choose to be more hands-on with your investments, thankfully the user interfaces for most robo-advisors are intuitive and make it easy to change your priorities.
CON: A Robo-Advisor May Not Weather A Financial Crisis Well
When you have a traditional financial advisor, he or she can take you by the hand and walk you through the best course of action when the economy suffers a downturn… They may also be able to warn you when trouble is brewing, and help you get out ahead of it. Although the models and algorithms driving robo-advisors should weather hard financial times well enough, it’s impossible to say for sure how they’ll perform in a recession — the first robo-advisors weren’t launched until 2009, and the 11 years since, we’ve only had positive growth in the economy.
So, Are Robo-advisors Right For You?
If you’re interested in a robo-advisor, your next step is researching what products exist and who offers them. Five of the most popular robo-advisors operating today are as follows:
They aren’t the only ones, of course, but these guys are a good place to begin your research.
Eric Gross, the author of this post, is a freelance financial writer in Texas, where he lives with his partner and two children. He writes about personal investing and financial topics.
More on HerMoney:
- When Do You Need A Financial Advisor vs. Just Some Financial Advice?
- Should You Use A Robo-Advisor?
- 4 Great Retirement Saving And Investing Tools