What is a RoboAdvisor?
Put simply, it is managing money through software that makes decisions based on inputs from you (human) and allocates your money into index funds. It's basically a computer making your investment decisions based on your inputs. I'll tell you why it's a great idea.
I’m often surprised at how often I get questions from friends about investing and managing money. What are the best stocks to pick? Where should I put my money? If I knew, I certainly wouldn't be writing this blog post - but, over the years I have learned enough about investing to know that Roboadvisors provide a great service for people who want to invest but are nervous about the legwork of research (and even for those that like doing the legwork like me). There is a lot of news about these types of advisors and their impact on the financial services industry. But shouldn't I use an advisor (human) like my parents to get advice? I'm not advocating that you shouldn't, but will suggest that roboadvisors are great low cost way to get the same type of advice.
One of the greatest investors of our lifetime is actually a great case in why Roboadvisors can work well vs. human investors. As described in a 2016 letter to Berkshire Hathaway shareholders, the multi-million dollar wager, which officially ended in December 2017, began in 2007 when Buffett predicted that the S&P 500 stock index would outperform hedge funds. He argued that, over time, active investment management by professionals would under-perform the returns of amateurs who were passively investing.
Warren Buffett has famously said a standard market index fund (a fund you can buy like a stock that holds thousands of stocks, like VTI) is his recommendation for everyone. Robo advisors give you a well-diversified portfolio, catered to your risk tolerance, and add in benefits that help reduce your taxes. If the greatest investor thinks that index funds are the best way to build wealth, and roboadvisors invest in index funds at a very low cost, why wouldn't you listen?
Pros and Cons of Robo-advisors
Not everything is gravy when it comes to robo-advisors. When deciding which advisors may make sense, here are some of the pros and cons I think about.
Pros
Lower Fees Than Traditional Advisors
Robo-advisors charge a percentage of your assets under management that typically scale as your portfolio grows. For example, Betterment, a well known advisor, charges 0.25% of your assets annually with a minimum of $0, which includes personalized financial advice, automatic rebalancing, among other things. Then, they have a premium package that charges 0.40% for all of their basic plan PLUS advice on things off Betterment, like real estate, 401(k), among other things. The services in the premium bucket at a traditional advisor (think the person at a local investment firm or even a national firm like Morgan Stanley) would be between 1-2% of your assets annually. The fees on robo-advisors are often times more than 50% less than traditional advisors.
Easy Access to Your Money
Most robo-advisors are online, so you can withdraw your money pretty easily through their platform. This is similar to a checking account, with the exception that there are tax consequences on any investment gains or losses you may have. Traditional advisors you may need to call, submit a form, or maybe other hurdles.
Reasonable Returns Based on Risk Tolerance
Over time, you want your portfolio to grow at a steady rate. Robo-advisors fit this bill. This all depends on your risk tolerance, but this Barron's article outlines two-year returns of some advisors, with returns upwards of 27%! I would say that is pretty solid.
Cons
Can't I just do this myself?
I think the biggest area of concern is simply this - if they're just investing in index funds, can't I do i myself and only pay the trading commissions and not pay an annual fee? Short answer is yes. However, the fee is so small that it's worth it (in my opinion) to simply pay the annual fee and let the machine do it for you.
Which Advisor to Use?
Personally, I use Wealthfront for my investing needs.
Everyone is different, but here are the reasons I choose Wealthfront
- First $15k is managed for free, forever
- 0.25% management fee is pretty low and competitive with other competitors.
- Truly based on technology and have a solid investment methodology.
- Direct Indexing, where they will buy stocks instead of ETFs for more tax loss harvesting and fewer ETF management fees
Should I use a Robo-advisor?
If you're looking to invest, are a little overwhelmed by the choices, and don't want to pay a ton of money for advice from a person, then yes. There are many to choose from, but I have had great experience with Wealthfront over the past few years. In fact, I have a 529 Savings Plan for my child through Wealthfront, too!
Hopefully you find it as easy as I have to start building your portfolio.
