With the technological revolution we’ve undergone over the past two decades, it’s no wonder we’ve seen a rise in robo-advisors. Why pay a human to do it when a robot (or a human and a robot) can do it for you, for less?
In this post, we’re going to dive into the good and the bad with regard to robo-advisors. We’re also going to explain how they work, and whether or not you should use one.
There are a lot of good things to be said about robo-advisors. For one, they are easy to use. Most of them come with a short questionnaire, and once you fill that out, it picks an allocation for you to use.
Another thing that makes them so easy is almost all of them are automated. That’s not to say robots are managing your money (though they kind of are); it has more to do with the automation of contributions, rebalancing, and reallocation.
One more huge positive about robo-advisors, they’re affordable. Most of them utilize ETFs, which are a low-cost investment vehicle. Additionally, there isn’t a lot of trading done, so transaction costs are low.
They are great for managing your long-term (retirement) investments because you can, essentially, set it and forget it. As long as you check in annually (at least) and keep up your contributions. However, with advantages come disadvantages.
The biggest drawback of robo-advisors is they lack that human touch. They are great for managing your long-term investments, but they aren’t a financial planner.
They can't tell you if you’re saving enough for retirement, help you save for your child’s future education, or help you set up your estate plan.
What’s more, when the market starts to tank and people start to panic, it’s that human advisor that coaches them into waiting it out. The human advisor saves them from the panic sell. The robo-advisor can’t do that.
Now there are some platforms (Vanguard for instance) that have a person available to talk to, but it comes with an extra cost.
How Robo-Advisors work
Getting started with a robo-advisor is pretty straight forward. First, you’ll sign up. Next, they’ll have you fill out a questionnaire. It’s designed to figure out your goals, risk tolerance, and your time horizon.
With the answers you feed it, it’ll spit out what it thinks is an appropriate asset allocation. Once that is established, you’ll go through and set up your financial information. Periodic contributions and such.
Going forward, the robo-advisor will automatically rebalance depending on how the investments in your portfolio performed, and how out of whack it is with your original parameters.
Should you use one?
I’m a human advisor, so I have a pretty strong bias to say no, but I’m a huge fan of them, with one exception. I would only advise you using them for your retirement savings, and I would recommend coordinating with a financial advisor to make sure that retirement savings are on track.
For all the great reason I listed for using a robo-advisor, they can only help you in this one area. Having a human draft you a plan, and visit with you on a regular basis to make sure you are on track to meet your goals is essential.