It’s been a while since I last updated my site. The reason for my absence has been due to my new role at work. This post will likely be my last syndication post for a while. I’ll write about my experience of trying to take blogging relatively more seriously some point next year and try to briefly explain what I learnt from the process.
From hereon, I will return to writing my own posts here and there when I find the time to.
To end the year, here is a post by Kevin who gives his opinion on robo-advisors.
I personally don’t use them, but I can see how they can benefit some people who are new to investing. For me, if it used, it would only be for a relatively short period of time until someone is comfortable with the idea of investing. Once they understand some of the basics of investing as well as a genuine recognition of their tolerance towards risk, then they would probably be better off going the 100% DIY route.
I hope you had a lovely Christmas and a Happy New Year!
Robo-advisors might not be as inherently exciting as the 1966 Western Classic starring Clint Eastwood, but they are certainly more modern. 42 years after the debut of this Eastwood blockbuster, the first Robo-Advisor came onto the scene. And 11 years after that, we’re stealing the title of that movie classic to create our own Hollywood film (article), starring Robo-Advisors.
So grab your popcorn, fill up your 48oz cup of soda, and silence your cell phones – we’re embarking on a journey that every modern investor should complete.
The Good, The Bad, And The Ugly – Robo-Advisor Edition.
Ever wonder why robo-advisors are getting so popular? And what the catch is (there is always a catch…)?
Well, you’re in the right spot.
We’ll start at the beginning, with some character development of our lead star: robo-advisors. And then dive into the three parts of this 2019 blockbuster article:
- Part 1: The Good – The Pros of Robo-Advisors
- Part 2: The Bad – Things Robo-Advisors Could Improve
- Part 3: The Ugly – What We Can’t Stand About Robo-Advisors
New Robo Advisors seem to be popping up a lot these days. You know how that is, right? It’s popular, it’s getting traction, so everyone wants to dive in. Betterment was among the first. Schwab jumped in soon after. Since then, we’ve seen numerous players enter the market – Wealthfront, M1 Finance, Wealthsimple, Ellevest, Blooom, Personal Capital, and SoFi, to name a few.
What Is A Robo-Advisor?
Robo-advisors strutted onto the scene in 2008 during a global recession. And they have only been gaining in popularity ever since then.
Robo-advisors are online platforms that do 99% of the work for you when it comes to investing. Most will ask you to complete a series of questions before opening an account. Then, the robo-advisor will automatically select investment vehicles for you based on your answers.
Behind the scenes, robo-advisors are employing an algorithm that buys and manages investments for you – optimizing and reallocating your portfolio to match your goals.
They have been gaining in popularity recently due to their efficiency, low costs, and easy-to-use online interfaces.
Robo-Advisors: The Good
There is plenty of good to find with robo-advisors. But overall, we’ve seen most of the benefits of robo-advisors revolve around one thing:
Robo-advisors make your life easier in a lot of ways. Just like credit cards simplified the buying of goods and exchanging cash, robo-advisors have simplified investing. And they didn’t take any shortcuts while doing it, either.
Most of the time, the benefits they offer are things that financial advisors couldn’t do (or would charge an arm and a leg to do for you).
It’s straightforward to get started with a robo-advisor. Most operate the same – to open an account with them, you first need to answer a set of questions.
Luckily, the questions are usually pretty straightforward. They revolve around either getting:
- like your email and date of birth, so that they can open accounts on your behalf.
Investing Details: like what your goals are and when you want to retire, so that they can optimize your accounts to fit your needs.
In most cases, you answer these basic questions. The robo-advisor does the rest. That’s much simpler (and less time consuming) than trying to do it all on your own.
Of course, robo-advisors will manage your assets for you ongoing. I mean, that’s the whole point of getting started with them in the first place!
Once your portfolio is set up (which they do based on the guidance from your initial questions), they will continue to manage your portfolio. As you age and your investing goals change, they will change your portfolio.
Plus, they usually offer a sleek online platform for you to track your progress as you go.
The most complex service that most robo-advisors offer is tax optimization. This can take many forms, but most commonly, it is ensuring your assets are in the right accounts and tax loss harvesting.
Asset Location: Smartly investing your assets across your accounts can save you money in taxes over time. Robo-advisors typically put tax-advantaged investments in taxable accounts where they can and vice versa. Let’s say you have an asset that is not taxed (like a municipal bond). They will ensure that it is not sitting in a Roth IRA and wasting the tax benefit that a Roth IRA provides.
Tax Loss Harvesting: Tax-loss harvesting can save you money when investments decline in value. Put simply, if you invest in a broad index fund that drops 10% one year, the robo-advisor will sell that fund and purchase a new, similar one instantly. This will allow you to write off those losses while staying invested in very similar assets the whole time.
Yes, their name has “robo” in it, but that does not mean there is no human touch or customer service.
Most robo-advisor companies still have real people you can chat with if needed, which I find reassuring. And, some even offer professional advice as needed (though, it usually comes with an added cost).
Last, but not least, the fund selection within robo-advisors – most of the time is very good.
Very good, meaning it’s full of low-cost index funds or ETFs, which is what I (and a lot of people) would be investing in on my own anyway.
For example, Betterment is full of funds from Vanguard and Charles Schwab, which are two of the leading companies in offering low-cost index funds and ETFs. Both offer funds with expense ratio fees below 0.05% (which equates to just $5 in fees annually per $10,000 invested)!
Robo-Advisors: The Bad
It’s not all roses and butterflies in the Wild West, and it ain’t that here either. Robo-advisors have their downfalls, and we’re entering the thick of the plot now!
What comes with simplicity is usually a lack of customization and detail. And in the case of robo-advisors, the result is no different.
Lack Of Customization
When you sign up for a robo-advisor, you are essentially signing away your right to customize and build your portfolio. Sure, they have a good selection of funds under their belt. However, they don’t have nearly the full range you would have if you were investing on your own.
On top of that, robo-advisors are deploying simple strategies. And while these simple strategies are great for 90% (or more) of investors, it means that you can’t easily invest in real estate or other sectors that might interest you.
For better or worse, you get locked into their plan.
Lack of advice
Though Betterment and other Robo-Advisors now offer CFP®s (certified financial planners) for an additional fee, the planning they do is limited. If you’re looking for an ongoing relationship with someone who can guide you, it will be hard to find at most Robo-Advisors.
I’ll offer my suggestion on the best place to get advice shortly.
Lack Of Detail
There is also an inherent lack of detail when it comes to robo-advisors. Yes, that short survey you complete when opening up an account is easy and straightforward, and that comes with a tradeoff.
How much can a robo-advisor learn about you in a few questions?
Can they get your investment strategy right with such little information?
For most people, yes, I believe they can. But there is a risk in the lack of the detail that they request and operate on.
Robo-Advisors: The Ugly
We made it – the final scene.
The horses are tired — our guns out of ammo. The wild west adventure ends here.
Luckily, there is only one ugly truth with it comes to robo-advisors, and it is their cost.
Look, robo-advisors are a steal compared to most financial advisors and actively managed mutual funds. In this case, the “ugly” call out is relative to all of the other items considered above.
The cost is the worst thing about robo-advisors, but it isn’t always a deal-breaker.
Most robo-advisors charge about 0.25% for their services. Of course, the fee varies by company, but it’s a good rule of thumb and average.
With a fee of 0.25%, on every $10,000 the robo-advisor manages, they charge $25. That’s how the firms make money and keep the lights (servers?) on.
Compared to an actively managed fund that charges 1% or more, this is a steal, as I mentioned.
But compared to investing on your own, this is a real cost that can add up.
When investing on your own, if done wisely (through Schwab, Vanguard, or another reputable online broker), you’ll face fees of around 0.10%. If that. There are many funds out there charging 0.03% or lower.
That’s less than half the cost of what a robo-advisor will charge in management fees. And the worse part is, the robo-advisor will also charge you for the fund fees.
So, if you’re invested in funds with an average of 0.10% fees, in our example, the robo-advisor will charge you 0.35% (0.25% management fee + 0.10% funds fees).
Now you have to decide – does the value that robo-advisors bring (“the good”) outweigh the costs (“the bad” and “the ugly)?
Alternatives To Robo-Advisors
Yes, this story has been entirely focused on robo-advisors so far, but there are a few other investment alternatives that deserve at least a supporting role in this feature.
Do It Yourself Investing
Managing your investments will almost always be the most affordable way to invest. It’s also the most time-consuming. And not everyone has the desire, motivation, or knowledge to do so. I’ve written a post that may help any readers who want to get started doing their own investing – complete guide to index investing for beginners.
Hiring A Financial Advisor
Hiring a financial advisor can be expensive, but it doesn’t have to be. It’s incredibly challenging to know where to look for a financial advisor. Additionally, if you find someone who looks good, how do you know if they are?
If you find the right financial advisor, they might be cheaper than a robo advisor. Index funds have brought down mutual fund fees and forced existing funds to adjust. Robo-Advisors are a part of that competition. Competition has forced planning firms to change their pricing to stay relevant.
Fees for financial planning
In the old days, advisors got paid commissions generated from transactions. Competition forced them to move toward an asset-based fee. They charge a percentage against the assets they managed on your behalf. The average price often quoted is 1%. So if you had $250,000 invested, your annual fee for an advisor to manage it would be $2,500.
Competition from flat-fee financial planning firms is bringing down and, in many cases, eliminating asset-based fees. The more progressive firms offer planning AND money management services for a flat-fee or via a subscription-based fee. A flat-fee means planners would charge, say, $1,000 to do a comprehensive financial plan. Some charge a flat fee for everyone, regardless of size and complexity. Others, have moved to a subscription model only.
We still think it’s better to take control of your finances and do things yourself. However, we realize it’s not for everybody.
That concludes our 2019 epic sequel to the western classic!
What we lacked in shootouts and dramatic sunsets, we hopefully made up with useful information! You are now ready to navigate the Wild West that is the world of robo-advisors! And for those who need and want financial advice, you now have an excellent place to check out.
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