Up until a few years ago you had two options when it came to investing: you either went completely solo – meaning you handled all aspects of investing on your own – or you hired a financial professional to help you along the way. For this help, you were charged a fee and in some cases, the person you were trusting with your money was looking out more for their own best interest rather than yours. But technology has been revolutionizing the investing scene and along with it has come another option for investors: robo advisors.
Robo advisors are a hybrid between having a professional hold your hand and you striking out on your own. The question you need to ask yourself is whether or not you would benefit from a robo advisor or not. In this post, I am going to help you try to answer this question. Let’s get started.
Defining A Robo Advisor
Before we get into all of the nitty-gritty, I want to make sure you fully understand what a robo advisor is. If you have read my post about Betterment, you have a good idea, but many of you will be new to the topic so I want to take a minute to explain robo advisors in general. Here is how the process works:
- You open an account with a robo advisor firm
- You answer a few multiple choice questions about risk tolerance, your age, and goals
- The system crunches your answers and provides you with a custom portfolio for you that is diversified
- You set up an automatic transfer into your new account each month and the robo advisor invests the money for you
In addition to investing your money, most robo advisors also reinvest dividends for you, they tax loss harvest your portfolio and even rebalance it. The price for this varies but is usually no more than 0.50% of assets you have invested. (Note that all of this information is general and each firm offers their own process, which you will see below.)
So now that you know what a robo advisor does, the question becomes should you choose to invest with one? While I cannot say one way or another because I don’t know your specific circumstances, I do feel a robo advisor is an option you should at least consider. Here is why.
Advantages of Robo Advisors
There are many advantages to using a robo advisor versus going solo or hiring a full time financial advisor. Here are these advantages:
Easy Access: anyone can sign up for these accounts. Some have a minimum initial investment of just $10.
Low Minimums: If you want a professional to help you with your investing, you better have some assets. Most advisors won’t look at you unless you have $250,000 or more to invest with them. That amount disqualifies the majority of people. With a robo advisor you need $10 to start in many cases while in others you need $5,000.
Professional Advice: Assuming the point above and you don’t have $250,000 to invest, you are left to do it yourself or trust some “expert” like Dave Ramsey who has no clue about your finances (while I agree with his debt advice, don’t get me started on his investing advice.) The robo advisors give you professional management for a reasonable cost.
Easy To Use: I know there is a ton of investing information out there and you can easily get confused. All of this information scares many investors. These investing firms make it easy to get started with investing. When I opened my account, it took me 10 minutes.
Low Cost: Free is good, but sometimes paying for help is worth it in the long run. The fees these investing firms charge is more than reasonable when you compare them to many other advisors out there. Many advisors will charge you 1% or more. The robo advisors will charge you roughly 0.50% or less. For the service they provide, that is worth it. (Especially since they offer 99% of what a traditional advisor does. I was surprised to see Betterment offering everything the financial planning firm I was working for offered for a much lower price.)
Take Out Emotions: Emotions are what cause so many investors to fail. We get scared and sell when we shouldn’t. We get greedy and buy when we shouldn’t. When you sign up for a robo advisor, you are buying more shares each month. It is basically dollar cost averaging. You buy less when the market is rising and more when it is falling. It sounds wrong, but it is exactly how you should be investing – consistently over time, regardless of what the market is doing.
Performance: The goal for most robo advisors is to put you in low cost investments that will track the market. What the market gives, you have to take. This is a good thing because you aren’t trying to beat the market. While you might succeed at this one year, you can’t beat the market every year.
Based on Science: Most all robo advisors base their portfolio construction on modern portfolio theory and the efficient market hypothesis. While you don’t have to understand these, know that they are the basis for modern investing today.
Disadvantages of Robo Advisors
Of course, there are drawbacks to these firms as well. Here are some of the bigger ones.
Algorithm: As I mentioned before, they use an algorithm to choose your portfolio and the assets that are in the portfolio. You can’t substitute one ETF here or there. You have to go with what they picked for you.
Garbage In/Garbage Out: If you don’t provide honest answers to the risk tolerance questionnaire, you are going to be placed into a portfolio that isn’t right for you. Most likely you will lose money or it won’t grow like you need it to, get frustrated, sell and move on to another firm. You have to put in honest answers if you want this to work.
Lack Personalization: When you deal with robo advisors, you are dealing with computers spitting out the information. There is no human element involved. Some are fine with this, while others want a hand to hold. While some robo advisors will have a person for you to talk to, most do not.
All of The Robo Advisors
When Betterment and Wealthfront, two of the leading robo advisors came on the scene, the big boys just laughed. But now that Betterment has over $3 billion assets under management and Wealthfront has over $2 billion, the big boys aren’t laughing any longer. In fact, they have all started their own robo advising practices to compliment their traditional offerings because studies show that by 2020 robo advisors will control 6% of assets under management or $102 trillion dollars.
Because of this, the likes of Vanguard and Schwab have started a segment in their offerings related to robo advising .They realize that this form of investing is here to stay and they need to get on board now before it is too late.
In the chart below, I break out each of the firms that are offering robo advising services, their minimum investment requirements as well as the annual fee they charge.
|Features||Betterment||Wealthfront||Motif Investing||Charles Schwab||Vanguard||Ally Investing|
|Open An Account||Open An Account||Open An Account||Open An Account||Open An Account||Open An Account|
|Assets Under Management (AUM)||$3.5 billion||$3 billion||$1.1 billion||$5.3 billion||$4.2 billion||$12 million|
|Minimum Deposit||$10||$500||$250||$5,000||$50,000||$5,000 (Core Portfolios); $25,000 (Momentum Portfolios)|
|Tax Loss Harvesting||YES||YES||NO||YES (Account balance of $50,000 or more)||YES||YES|
|529 Plans||NO||NO||NO||NO||YES||No 529 but Coverdale Account|
|Retirement Planning Tools||YES||NO||NO||NO||NO||NO|
|Open An Account||Open An Account||Open An Account||Open An Account||Open An Account||Open An Account|
As you can see, many firms are offering this service and the investment minimums vary but the fees are reasonable. While this chart is helpful, it won’t tell you the full story. You have to decide what features are important to you and then see which advisor offers those to you. In other words, no two robo advisors are alike.
Below is a little more detail about each firm, but I encourage you to check out their sites and do more research so you can be certain you are going with the one that makes the most sense for you.
Betterment: Betterment is one of the originators of automated investing along with Wealthfront. They are one of the firms I use to invest with and like them. The process is simple and I get emails telling me when things are happening in my account. You can start off with just $10 which means anyone can start investing. Their fee structured is tiered, so the more you invest, the lower their management fee becomes.
Wealthfront: The other originator, Wealthfront is comparable to Betterment in every way. One difference is that you need more to get started – $500 – but that shouldn’t be an issue for most investors. The other difference is fees. Betterment charges a fee in a tiered structure whereas Wealthfront has a flat 0.25% fee. So, you will pay a little more in the beginning but will pay less as your account grows larger with Wealthfront.
Motif Investing: Motif began as a place to trade stocks on the cheap but has gotten into the robo game with their Horizon Funds. They are a company you don’t really hear much about compared to to the big guys – Betterment and Wealthfront – but like Schwab, robo investing with Motif is free. I think they will be gaining momentum as word gets out about their program. And honestly, I am looking into trying it out myself.
Charles Schwab: Schwab is a traditional online broker and got into the automated investing game last year. The fact that they charge zero fees has made them a serious player in this niche. They do tend to put you in a more conservative portfolio, but I think this is a good thing. We all tend to not equate risk and reward well enough and Schwab taking the more cautious route is a smart move. The only downside to their program is you need $5,000 to get started.
Vanguard: The mutual fund king is trying to add more clients with their personal investing services. With a name like Vanguard, people are flocking to their program. While the fee they charge is incredibly low at just 0.30% compared to most financial advisors, you do need a chunk of change – $50,000 – to get started. But the thing that really interests many people who go with Vanguard is that you talk to a human and can have some input as to how you are invested.
TradeKing: Yet another newer entrant into robo advising. Like Wealthfront, they have set fees – either 0.25% or 0.50% – on their portfolios. As with Vanguard and Schwab, you do need a little more to get started with TradeKing. You need $5,000 to invest in their Core Portfolio and $25,000 to invest in their Momentum Portfolio.
Should You Go With A Robo Advisor?
Investing on your own is tough. You have to know the basics at a minimum and then be in tune with your emotions so that you don’t get excited or scared at the wrong time and make the wrong move. This is why many want to go the route of a traditional investment advisor. But the issue with account minimums comes up as do the fees.
Robo advisors meet this need. They offer you the professional guidance for a reasonable price. Once you set up you account, the robo advisor will handle all aspects of your portfolio while you sleep or play with your kids. In other words, they do the heavy lifting and you don’t need to worry.
So if you want to get started but don’t know the ropes or have hundreds of thousands to invest, a robo advisor might be the right fit for you. The most time consuming part will be picking the one you feel meets your needs the most. Once you do this, setting up an account and getting started will be a breeze.
[Photo Credit: Peyri Herrera]