The Ultimate Guide to Investing Using Robo-Advisors
Since the industrial revolution, automation has expanded the horizons of human possibility. Machines turn complex human processes into huge industries. They can replicate the work and skill of a person thousands of times with greater accuracy.
In the digital age, there aren’t many areas left untouched by automated processes. A lot of the time, these work best when combined with human expertise. In the world of financial investment, both are being put to use in the form of robo-advisors.
Whether you are an experienced investor or looking to make your first steps in the world of financial management, you will be looking for the most efficient way of maximizing your funds at a comfortable level of risk.
Traditionally, a financial advisor’s experience has been the only option to guide you through an investment strategy, other than figuring out what to do on your own. One of these costs money, the other costs time.
If you’re interested in investing, you may well have heard of robo-advisors. They provide financial guidance based on algorithms using cutting edge research. For a much smaller fee, robos offer focused advice and plan your investments in line with your objectives.
In recent years the robo-advice market has grown rapidly, with brands such as Wealthfront and Betterment controlling billions of dollars. As with any emerging technology, though, it’s natural and right to be cautious. So often, hype exceeds the reality.
In that spirit, we’ve taken a deep dive into the pros and cons of robo-advisors to help you get a clearer picture of what they can do for you and your money.
Robo-advisors offer a balance of control and automation.
1. Personalized Parameters
Like all good investment strategies, robo-advisors are designed to be specific to your situation. Most robo-advisors will establish parameters based on where you start from and what you want to achieve.
You might be an experienced investor looking to diversify your portfolio through a new strategy or a first-timer looking for a way into the market. This is an adaptable approach for both. Your budget, risk tolerance, and financial goals will all be taken into account to build a portfolio designed to get you where you want to be.
If you have particular areas of interest, these can also be taken into consideration. Perhaps you want to focus on eco-friendly companies or invest in the future of healthcare. Robo-advisors will help to ensure your money is supporting industries you care about.
2. Low Barrier to Entry
While it’s not the cheapest option, robo-advisors are likely to provide an acceptably low fee for managing your investments. The low fees available make robos more appealing than traditional financial managers. Certainly for the majority of investors who are not professionals and lack time to manage their finances themselves.
Other all-in-one options might cater to your needs. Ensure you’ve checked these out as well before diving straight in. Companies like Vanguard may have a ready-to-go investment strategy that suits your needs between 0.12% and 0.16% per year. Compared to a typical fee of 0.25-0.75% through a robo-advice platform like Nutmeg, this could well be a better option. Your situation will determine whether this difference is negligible.
If you want to combine low-maintenance management with basic personalization and flexibility, then robo-advisors fees will probably work for you. But, as with any serious financial decision, research is paramount.
Investing isn’t for everyone. But, if it’s time to see what your money can achieve, robo-advisors will navigate the complexities for you.
This means that, after deciding your parameters, there is little more you need to do besides checking in on your investments when it suits you. Like most successful online products, accessibility is key, and all-in-one, desktop app solutions, can be found across various services. Such is the case with robos, making the process similar to online banking or managing your emails.
The automated nature also cuts down on time you would previously have had to spend on researching investments yourself or paying for a financial advisor’s expertise. The robo-advisors cut a lot of this out. Of course, it is still worth taking the time to consider which of the many robo-advisors out there is right for you.
Some of the finer details will differ between providers, but many of the key benefits are consistent. Ready-made portfolios are a common feature, providing automated investment designed by human expertise. While this means your portfolio isn’t unique, it will still be in-line with your risk and goals. It also benefits from the confidence that others are investing in the same way.
4. Automated Optimization
As an investor, your primary concern will be maximizing your return in harmony with your risk tolerance. One of the important areas of expertise you don’t want to miss out on, therefore, is tax efficiency.
Luckily, robo-advisors work this into the array of features that optimize your finances.
One major benefit most robo-advisors offer is automated tax-loss harvesting. This ensures that your taxable investments work in tandem with your other sources of income to maximize your returns after tax.
Many optimization features are working behind the scenes to ensure your investments are easy to maintain. A wealth of expertise and research has gone into the models robos are based on. Up-to-the-minute, Nobel Prize-winning best practice underlines the decisions they make. While no investment is without risk, robos are programmed with some of the soundest investment theories available.
Despite personalization being a key benefit of robo-advisors, there is something undeniably impersonal about this method. Again, it all comes down to what is right for you.
Even if investing seems like the way to go, it’s natural to feel nervous about putting your trust in an algorithm. Particularly in light of situations where they haven’t coped with the nuances of human life.
Robo-advisors don’t offer the same depth of advice as traditional finance experts. (Source:123rf.com)
It’s important to remember that algorithms improve over time, so we shouldn’t let certain examples tarnish our ideas of what they can do for us. For a fraction of the cost, robos can read markets and perform the same operations experienced by financial planners. Often, robos’ wide diversity of investments will out-perform the investment picks of financial planners. By keeping pace with the market rather than trying to beat it, the robos often make better judgments.
However, this is likely to work best for those in less complex situations. Some robo options will include hybrid approaches with humans that are on hand to answer questions here and there. This isn’t the same as having access to a dedicated, experienced financial planner.
It may double the fees, but if you’re working with large amounts of money, assets, or an estate, human expertise is likely to make you feel a lot more comfortable.
As with robo-advisors, it’s important to research when considering human-led services. Sadly, there are no guarantees we’ll be able to speak to someone in-person at a given point in the future. If you choose to pay the higher fees for a financial planner, make sure they have adapted to the disadvantages of online communication to meet their customers’ needs.
2. Not the Cheapest Option
Robos’ fees sit in the middle-ground between financial planners (around 1%) and simpler solutions like target-date funds (around 0.1-0.15%). Naturally, you wouldn’t want to pay for a service you don’t use. So it’s worth finding out about the cheaper option.
The appeal of systems like target-date funds is that they are low-maintenance and low risk. They are designed to be more conservative as the target date (e.g., retirement) approaches. For many investors looking to boost their quality of life, later on, this works perfectly.
If you can be slightly more ambitious, though, and work towards financial independence earlier, the higher fees of robos might be the difference that makes that dream a reality.
3. A Crowded Market
Given the success of robo-advisors, and the fact it’s new tech helping people grow their money, it’s no surprise there are many companies in the market. While the hard work of navigating investments is done for you, you still need to figure out who to invest with.
Just because you invest through an automated system, it doesn’t mean that, as a customer, you shouldn’t expect world-class customer service.\
Your robo-advisor will be making important decisions. Spend time researching. Image Credit: adobe stock; phonlamaiphoto
You will be trusting your robos to achieve your goals, and it’s worth making a shortlist of the companies that provide the services you’re looking for before investigating each one to ensure they meet your expectations. If they have a slightly higher fee, what can they offer beyond maintaining your portfolio that makes them worth it? If you go for a cheaper option, are you confident you won’t be missing something crucial?
Luckily, customers are quick to report unfair treatment, making it simple to weed out any options that aren’t likely to fit the bill. Before you begin investing, it’s worth making any inquiries by email or phone to help you feel confident. Businesses have no excuse not to provide excellent communications and customer service, so be wary if they don’t. It may also be that your company has worked with a video hosting platform to provide tutorials about how to manage your investments and allow for one-to-one consultations.
4. There Are No Guarantees
Finally, as with all investments, there is an inevitable risk involved, which means there are no guarantees. As an investor, it’s important to understand and accept that. Without risk, there can be no reward, and you should factor this into what is manageable and sensible for your situation.
Throughout any long-term investment, you will experience peaks and troughs. Hopefully, these will balance out over time, leaving you better off and closer to your goals.
So — is a Robo-Advisor Right for You?
Robos are a new player in the asset management game, and the competition in the market is great for new investors. It ensures a space in the market for people who want to pay low fees, target their investments, and have a low maintenance way to invest.
If you are in a strong financial position and willing to be a little riskier with your assets to achieve an ambitious goal (such as early retirement), robos may well be the best option out there.
If you’re just starting and are looking for a manageable way into investing that fits into a busy lifestyle, again, robo-advisors could be what you’re after.
Experienced investors may be skeptical about new technology when they have seen success through more traditional methods.
Whatever your financial situation, we think it’s well worth spending some time investigating the specifics of what robos have to offer. If you’re looking to grow your money, know your level of risk, and have a long-term goal in mind, a robo could be the solution.
Image credits: iStockPhoto