I’m sure you have heard of the term robo-advisor. I am also sure that you are terrified of letting a “robot” handle your funds. Let’s clear the air on the subject in this article. Let’s start with the formal definition:
A robo-advisor is an automated system that uses pre-defined algorithms to manage assets for clients, based on their risk-tolerance and other factors.
Sounds a bit complicated, doesn’t it?
Simplified definition: A robo-advisor is a computer program that does the job of picking stocks and assets for you based on your goals and the level of risk you are willing to take. In some cases robo-advisors are a mix of human intervention and automated programs. In fact, when it comes to dealing with robo-advisory firms, there will be a human element in terms of service such as answering queries, troubleshooting, etc.
So What Exactly Does A Robo-Advisor Do?
Robo-advisors usually use ETFs, BUT they are not the same, because there is a possibility to tailor robo-advisor portfolios to suit your needs, albeit, only to a small extent. For instance, you can choose a portfolio that provides a high level of exposure to the coffee sector. Furthermore, robos use a combination of ETFs within different asset classes. For instance, you could have three ETFs in a robo suggested portfolio – one each for stocks, bonds and gold. Hence, for most investors switching over to robo-advisors was a no-brainer.
Why Are Robo-Advisors So Popular?
The recent popularity of robo-advisors is due to two main reasons. First, robo-advisors are more affordable because unlike brick-and-mortar mutual funds, they have few overhead expenses. This means they can charge lower fees. Also, portfolio managers were/are quite horrible when it comes to providing good returns and until recently, mutual funds were more about clever marketing than anything else.
Secondly, with robo-advisors, advanced investment strategies become accessible to the average investor with limited recourses. In fact, strategies used by these robos are based on works of prominent researchers and Nobel Prize winners.
However, there is no perfect portfolio management strategy that has been devised as of yet, and thus, investors should not expect the moon. Furthermore, there is yet to be an extensive long-term study that compares the returns of robos with that of ETFs and market indices. One needs to understand that robo-advisor algorithms have been designed by humans, the only difference is that they take the element of emotions out of the asset picking process.
What other benefits do robo-advisors provide?
Automatic rebalancing: If you hold a portfolio with a number of assets, it will have to rebalanced on a regular basis as the value of the securities will change. The task of rebalancing can be both difficult and expensive. With robo-advisors, you don’t have to worry about this process.
User-friendly technology: Dealing with an advisor can be an intimidating process. Most robo-advisors have an approachable and interactive interface that one can play around with. This also means that you have access to your portfolio 24/7 – you can invest, withdraw money and check your balance whenever and wherever you want.
What are the disadvantages of using a robo-advisor?
Personalization: Even though robo-advisors can be tailored to suit your needs to a certain extent, they are more of a one-size-fits all solution. Sometimes investors have complicated needs and circumstances, such as estate and tax planning, where they would want the advice of a professional advisor.
Moreover, there are some investment strategies, such as value investing, that an algorithm isn’t intelligent enough to use. Take for instance investing in the stock of Google requiring good in-depth qualitative analysis. Unless there is an artificial intelligence that can think like Carl Icahn sometime in the near future, the human element in investing will always exist.
Not always cheap: As mentioned before, robo-advisors are cheap, or rather, cheap-ER as compared to SOME mutual funds. You can find funds that charge a 1% fee, close to that of some robos.
Should you invest with a robo-advisor?
The answer is that “it depends”. Are you someone who can, or wants to pick winning stocks on a consistent basis? Then no, it would be a bad decision to go for a robo-advisor.
Other factors to take into consideration:
1. Do you have special needs such as estate and inheritance planning? A robo-advisor would be a bad idea as you would need a tailored solution.
2. Are you okay with constantly monitoring your investments? If yes, then stick to investing on your own.
3. Are looking for MUCH more than average returns? A robo-advisor will not provide you a 20% return. Also, as mentioned before, we still don’t know if they perform better than other comparable options.
4. Do you have a limited amount of money to invest? Go with a robo-advisor. And in case you are a beginner to the world of investing then, this will also be a good way to get your feet wet and eventually move to complicated investing methods.
In conclusion, robo-advisors are definitely a great option to have, but one needs to be wary of the hype and marketing efforts. Nonetheless, it is always better to try something for a short while before coming to a definite conclusion. Since the pay-in for a robo-advisor is small, you will not have to invest much to test the waters. Here is a great article on choosing the best robo-advisor for you from David Aston at Moneysense.