Pros and Cons of Using Robo-Advisors
If you're looking to get an edge in your investment portfolio without paying expensive fees, you may want to consider robo-advisors, the latest innovation in online investing. Before you decide, compare the pros and cons — while robo-advisors certainly have their advantages, they may not be right for everyone. Let's take a closer look to see if they are the right choice for you.
How Do Robo-Advisors Work?
Robo-advisors are financial software programs that automate the investing process. They use complex computer algorithms to buy and sell investments, rebalancing your portfolio based on your needs and risk threshold. Once you specify your requirements, simply step back and let the software do the work. You can invest lump-sum amounts or use a monthly deposit system for as low as $10 per month.
Adam Nash, CEO of the automated investment service Wealthfront, explains, "For decades, experts have been recommending that investors maximize their results by regularly rebalancing, reinvesting dividends and harvesting tax losses." Online services such as Wealthfront offer a personalized portfolio across multiple asset classes. They focus on your specific financial situation while automating the management of your portfolio.
Fees vary, but range anywhere from 0.10 to 0.35 percent per year. Additional fees may apply if the amount of your investment portfolio is below a specific threshold.
Robo-Advisors Compared to Human Advisors
For those who are somewhat tech-savvy, robo-advisors offer three main advantages over working with human financial advisors: Robo-advisors are available 24 hours a day; they are less expensive than humans; and they provide a way for investors to access their accounts directly — anytime, from anywhere.
On the other hand, robo-advisors might be less appealing to those investors who can afford a human financial advisor's fees; who aren't comfortable with technology; or who simply prefer working with a real person.
Compared to Mutual Funds
The idea of automating and diversifying an investment portfolio is nothing new, since mutual funds have essentially been doing the same thing for decades.
However, Nash notes that a typical mutual fund is handicapped by "a combination of high fees, low diversification and almost no tax optimization.” Robo-advisors on the other hand, “take into account the details of your personal financial situation to assess your risk tolerance. They also allocate your investments across a wider array of investment options, optimized to the type of account you are opening."
Such personalized features, along with sophisticated strategies to minimize tax consequences, are simply not possible in a one-size-fits-all mutual fund portfolio.
Objectivity and Efficiency
Robo-advisors can be more objective than humans and aren’t lured by commissions or incentives to promote one investment over another. However, this advantage can vary depending on the service you choose. Robo-advisor software is still programmed by human beings who may not always be objective, and the programs tend to offer fewer investment choices than human financial advisors do.
Where robo-advisors excel is in the pace of their transactions. They are able to automatically sell investments at lightning speed when specified objectives are reached — this is difficult for humans to compete with.