Robo advisor has emerged in the past years. Today, investors have a choice which they didn’t have ten years back. They can now take investment advice from a human financial planner. Or they can seek the help of robo-advisor to maintain their portfolio.
Robo-advisors have flourished in the second-longest bullish market ever. These software platforms are growing exponentially now. Robo-advisors had $60bn in AUM by year end 2015. Financial services research company Cerulli published this figure. The firm estimates that this figure will increase to nearly $385bn by 2021.
Robo Advisor: What Is It?
Robo-advisors are online platforms providing automatic financial planning. These algorithm-based services need little or no human supervision. A typical robo-advisor gets client information including their current situation and future goals. It does this through an online survey. Then, it uses this data to provide guidance and automatically invest the assets.
Understanding Robo Advisor
The first robo-advisor was Betterment. It was launched in 2008. Yes, the year of the Big Recession. Their primary goal was to rebalance assets within target-date funds. This way investors could manage their passive investment via an easy digital interface. There was nothing new in the technology. Human financial planners also use automatic portfolio management software. This is in practice since the early 2000s. But until 2008, only they could purchase this technology. So, the clients had to use a financial planner to reap benefits from the innovation.
The introduction of robo-advisors has changed the complete scenario. Robo-advisors have eliminated the middlemen (human advisors) and deliver services directly to clients. After ten years of development, robo-advisors can now handle more complicated tasks. This includes retirement planning, tax-loss harvesting, and investment selection. The sector saw incredible growth as a result. AUM by robo-advisors touched $60 billion by 2015. This number is expected to rise to $2 trillion by 2020.
Robo-advisors also carry the following designations:
- Automated investment advisor
- Automated investment management, and
- Digital advice platforms
All these refer to the same client shift toward fintech applications for investment.
Robo Advisor: Who Can Hire One?
To be precise – everyone. The symbol of automatic advisory services is its easy access. But, several online platforms attract some specific demographics more than others. To name them, the younger group of Gen X and Millennial investors. These people are technology-reliant and still collecting their assets. This group is more comfortable in sharing their personal information. They also entrust technology with crucial tasks. Wealth management is one of them.
The industry is getting interested in Baby boomers also. Plus, the high-net-worth investors are also taking a liking for robo-advisors. Especially as the technology is improving every day. A recent study by Hearts and Wallets has some interesting findings. According to the study, half of the middle-aged investors and one-third of retirees use online resources for managing their money.
Robo Advisor’s Fees
When you use a robo-advisor, you pay a service fee. You also pay the expenses of the used investments.
Every robo-advisor charges an affordable service fee. This fee can be set as a proportion of assets or a fixed monthly fee. When using the former plan, the yearly fee ranges from .15% to .50% of the account size. Hence, if you’ve $100,000, a .50% fee will be equal to $500 per annum.
Robo-advisors are charging a monthly fee; the fee ranges from $3 pm to $200 pm. It depends on portfolio size.
You also have to pay expenses related to investments used. E.g., ETFs and mutual funds have expense ratios.
The robo-advisors take this fee out from the assets and give the remaining returns to investors.
Many such digital platforms offer free trials as well. So, you can test how it works for you before you start paying for the service.
Five Points of Distinction Between Human and Robo Advisors
Minimum Account Limits – You may have to keep at least $500,000 in assets when dealing with human financial advisors. Robo-advisors have little or no account minimums.
Fees – A human advisor charges a 1% yearly fee for portfolio management. Robo-advisors charge an annual fee between .25% and .50% of assets. Wealthfront waives the fee for your first $10,000.
Human Interaction – You have the option of calling a human advisor whenever you wish. Robo-advisors might charge an extra fee for face-time. Betterment charges you .40% for your $100,000 in assets and a yearly call with a financial planner. It charges .50% fee if you’ve $250,000 and above plus unlimited access to a human advisor — hybrid services which link you to a financial planner charge a high yearly fee. E.g., Capital One Investing levies .9% yearly for an account having at least $25,000.
Investment Choices – Robo-advisors typically make their portfolio with index funds. Human advisors offer you more investment options.
Tax-loss Harvesting – Most robo-advisors give automated tax-loss harvesting. This means selling an investment to produce a loss which offsets capital gains. Betterment predicts its tax-loss harvesting service can contribute .77% to a client’s post-tax returns. But, tax-loss harvesting is relevant only in taxable accounts. It won’t help your case if it’s in a tax-deferred account, a 401(k) or IRA for instance.
When to Use a Robo Advisor?
Robo-advisors could be beneficial in the following cases:
You understand the effect investment fee has on your investment performance. The amount you pay as fees can have a significant impact on your asset performance. This is especially true for the long-term. Traditional human advisors charge between 1% and 3% of your portfolio. But, robo-advisors don’t cost more than 1%. You can even get these automated advisors for as low as .15% p.a. Other things are remaining the same; this can increase your investment performance.
You don’t need too much direct interaction. Some prefer a personal connection with their investments. But, others don’t need it at all. If you’re happy that someone else manages your portfolio, robo-advisor is your answer. But make sure that you’re okay with not having a financial planner to talk to if the market crashes. These are the times when people want direct interaction with an advisor. Can you sail through the downtimes on your own? You don’t need a person who knows your investments, to analyze these downturns? If the answer to these questions is yes, then robo-advisors will work for you.
You’re unable to satisfy the minimum limit for a human advisor. The minimum account balance is one of the main limitations of human advisors. Most need you to carry at least $200,000 in your assets. If you don’t have this amount, they won’t even consider managing your funds. Others have even greater minimums, like $500,000. Some also go up to $1 million. Robo-advisors will offer portfolio management with as low as $5,000. Some even permit you to get an account without any minimum balance. This is a major reason for robo-advisors’ growing popularity.
You’re ready to allow someone else do you investing — all of it. When you opt for robo-advisor, the site will do all your investment activities. You need to fund your account. If you like this type of arrangement, then choose a robo-advisor.
When to Use a Traditional Human Advisor?
Despite the growing popularity of robo-platform, many still like a human advisor. This is relevant in the following cases:
You’re uncomfortable doing business online. Some people, especially younger groups, are fine with online business handling. But, not everyone prefers this. If this is you, then you should probably go with a human advisor.
You want direct human contact. If you like to have direct interactions about your investments, stick to traditional advisors. They’ll not just manage your assets, but you can also discuss your concerns with them. Robo-advisors also do give you some call access. But, no one is responsible for taking calls. They’re mainly there to answer queries about the platform.
You desire some control over your investments. Robo-advisors are quite hands-off. This is their main limitation. You’ll complete a brief survey to determine your risk tolerance level. Then the robo-advisor will design a portfolio depending on that tolerance. You cannot customize your portfolio. Plus, you can’t upload your portfolio with Apple stock. Many robo-advisors don’t have any individual stocks only.
You can’t come to terms with investment allocation these digital platforms use. Besides the lack of control over your assets, robo-advisors’ way of allocating may trouble you. It can happen that you may not like the allocation assigned to the portfolio. Because they’re automatic, robo-advisors don’t provide the investment flexibility which traditional human advisors do.
Much of your money goes in an employer-sponsored scheme. Such retirement schemes like 401(k) are managed directly by an investment trustee. Hence you can’t hand over the assets to robo-advisors. The maximum you’ll get is asset allocation suggestions from the robo. And you might not be able to apply those suggestions to your 401(k). If all or most of your assets are in your investment plan, don’t use a robo-advisor.
Limitations of Robo Advisor?
A cost-conscious investor may not think of robo-advisors as bad after all tax-preparers and tax-payers use tax-prep to fill 1040 forms every year. It seems to work well. So why should investors not depend on investment software?
The issue is the missing human touch. Investors, whether old or young, like when an advisor invests time in understanding their goals and story. A digital program can’t get this understanding, even through input from a survey.
As you near your retirement age, robo-advisors appeal a lot less. Their software still can’t do retirement planning. And, after 50, the investment concerns of people go above investment returns. Managing portfolio doesn’t match retirement planning or risk management.
Besides, robo-advisors came after the recession. Hence, they’ve only faced a bull market till now. They first began in 2010. Passive investment management is their forte. How skilfully will their software react and manage a portfolio during a downturn? This is yet to manifest.
Do robo-advisors have any fiduciary duty? Many human financial advisors take a fiduciary role for their customers. They have a legal and ethical obligation to give advice which in the best interest of the client. Do robo-advisors have the discernment of doing this?
The robo-advisor trend could be temporary. Why do you ask? This entire business model may mean the death of many of these companies. Robo-advisors fly high on their low fee and low account balance. But, as CNBC claims, these fees are now so low that many firms are now finding it hard to recover their client acquisition cost. Eventually, robo-advisors may go down the memory lane for one reason. That is, how they forced the financial market giants to provide low account minimums.
Robo-advisors are effective in many situations. But, as everyone’s temperament and case are different, you should consider your options. Don’t be too rash in deciding whether to go with robo-advisor or a human advisor. Weigh your choices and see what works better for your situation and investing style.
There’re many hybrid platforms as well. Some robo advisors now give investors the opportunity to speak with a live human advisor. This is applicable when account balance goes beyond a certain limit. On the other hand, some big brokerages have also launched robo-advisor platforms. They offer potential human contact to compete with the new firms who challenged the old-school way.
It seems the traditional approach of hiring a human advisor might be hard to disturb. The opportunity to have a discussion and learn from the experience of a human advisor is significant.
Having read this Robo Advisor: What Is It? Benefits and Limitations, What do you think? Do you believe robo advisors can replace human advisors? Please feel free to share your thought with us.
We are looking forward to hearing from you.
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