Wondering if robo-advisor investing (services like Betterment and Wealthfront) are right for you? Read this post to find out!
The following is a post by MPFJ staff writer, Toi Williams, who is a professional finance blogger for MarketBeat. She has backgrounds in personal finance, sales, and real estate.
One of the fastest growing segments of the financial services industry is the use of robo-advisors to provide financial advice at a minimal cost. Robo-advisors have surged in popularity as people have sought low-cost, automated investment opportunities. Survey after survey shows that most potential investors under the age of 60 would entrust their savings to a digital platform or mobile app capable of offering them a range of low-cost funds and personal investment advice, as long as the platform is credible, secure, and trustworthy.
Robo-advisors use computer algorithms and advanced software to build and manage a clientโs investment portfolios. Most of these platforms provide a wide range of services, including managing individual retirement accounts, taxable accounts, trusts, and your 401(k). Robo-advisors and mostly digital advice firms have captured more than $100 billion in client assets since their introduction and are expected to reach about $385 billion by the end of 2021.
The products were pioneered by online upstarts Wealthfront Inc. and Betterment LLC. Betterment, which was launched in 2010, and Wealthfront, launched in 2013 already have, respectively, $8.9 billion and $5 billion in assets under management. Analysts at Citigroup predict robo-advisors will be managing $5 trillion globally over the next decade.
There are some pros and cons associated with using robo-advisors for investing. Here are the things that you should keep in mind.
Ease Of Use
Your first interaction with a robo-advisor will almost always be a questionnaire, designed to determine your risk tolerance, goals, and investing preferences. The serviceโs algorithm will recommend a portfolio based on your answers to these questions Customers are generally offered between five and 10 portfolio choices, ranging from conservative to aggressive. On the conservative end of the spectrum, the portfolios are heavily weighted toward bonds and cash.
After the completion of the questionnaire and the selection of the portfolio, robo-advisors require little to no human interaction. Most robo-advisors offer regular rebalancing of the portfolio, either automatically or at set intervals, via computer algorithm, so your portfolio will not deviate from its original allocation. However, you can always make changes to the portfolio if youโd prefer a different option.
The Costs
Robo-advisors, also known as automated investing or online advisors, are often much cheaper than what youโd pay a human financial advisor. Most companies charge between 0.25 percent and 0.50 percent of a percentage of your assets under the robo-advisorโs care as an annual management fee, less than half of what is typically charged by traditional financial advisors. The fee is typically prorated and charged monthly or quarterly.
Robo-advisors largely build their portfolios out of low-cost exchange-traded funds and index funds. Youโll pay the fees charged by those funds in addition to the robo-advisorโs management fee. Minimum investment requirements can range anywhere from $0 to more than $10,000.
You also have to consider the cost of buying and selling your investments. In a standard brokerage account, you might pay a commission for these transactions, but robo-advisors frequently waive these charges.
Hybrid Services
There are also services that function as robo-advisor hybrids, relying on a computer but also offering clients access to human financial advisors. Customers can speak with these human advisors either on an unlimited basis or via a set number of phone calls throughout the year. The cost and minimum investment requirements of these services often increases in step with the level of human involvement allowed. However, these hybrid services can be a good option for investors who need human interaction to feel secure with their investments.
Conflicts Of Interest
Some investors are concerned that many robo-advisors are developed by or bought by consumer financial product intermediaries that have financial incentives to steer consumers to certain investments. This means there is a risk that the robo-advisor platforms offered by these companies could favor mutual funds and exchange-traded funds from companies that make payments to the platform owner. Throughout history, companies have paid financial institutions hefty sums for access to their wealthy clients.
Regulatory Concerns
There are limited regulations for online platforms offering a wide range of investment services. In February, the Securities and Exchange Commission issued a guidance saying robo-advisors are subject to the fiduciary and other substantive requirements under the Investment Advisors Act of 1940. The Investment Advisors Act requires clients’ interests come first when providing recommendations, among other standards. This year, for the first time, the SEC has added robo-advisors to its annual list of examination priorities.
The decision of whether to use a robo-advisor for investing requires careful consideration. Before choosing a platform to use, here are some things to look for:
โข Does the platform detail the degree of human involvement in the oversight and management of client accounts and how the robo-advisor uses the information gathered from the client to create recommendations?
โข Does the platform fully disclose the fees and costs that the client will pay, directly or indirectly?
โข Does the platform detail the limitations and particular risks of using the algorithm as well as any circumstances that might cause the robo-advisor to override the algorithm?
โข Does the platform disclose any third-party involvement in the development, management, or ownership of the algorithm and an explanation of any related conflicts of interest?
โข Are the disclosures presented in a way conducive to client understanding before they sign up for an account?
All disclosures should be in plain English and easily found within the robo-advisorโs online platform.
How about you all? Do you use a robo-advisor / robo-investing platform like Betterment or Wealthfront? Why or why not? Share your experiences by commenting below!ย
Share your experiences by commenting below!ย
***Photo courtesy of https://www.flickr.com/photos/23905174@N00/2061329074
