Investing has forever been a scary and confusing topic for many people. Trying to understand the movements of stocks and getting comfortable with the risks those movements pose can be difficult to understand and even more difficult to accept when putting our hard earned money into the hands of a financial advisor. Over the past decade or so, many companies have tried to make investing more appealing to the general public by creating robo-advisors as a way to simplify and streamline the investment process.
A robo-advisor is essentially a robot, or computer algorithm, that takes the place of a human being when it comes to managing investments. While removing the human element might seem scary, it also drives down costs. Robo-advisors operate under the assumptions that the people who use them will most likely adopt a buy and hold strategy and that asset allocation is the main determination of a portfolio’s performance. Basically, robo-advisors understand that most people just want to match the performance of the S&P 500. With a historical average annual return of about 10%, this is a great goal for people who want to grow their wealth, but not worry about the stress of stock picking and day trading. The portfolios established by robo-advisors rely on the user to select the desired timeline for use, and then use that information to set an asset allocation that makes sense for that timeframe. If you were to open an account with a company like Betterment, for example, and tell them that the goal was to use the money you are investing for a home purchase in 5 years, they would likely recommend a breakdown of 60% stocks and 40% bonds. If, however, you were planning to use the money in 15 years to support you during an early retirement, they would likely recommend a breakdown of 90% stocks and 10% bonds. These recommendations take into account the volatility of the stock market and correctly identify that if you need the money soon, you need to have less risk, which translates to less stocks!
The financial services industry has received a lot of negative press over the years. People complain that the industry has high barriers to entry, high fees, too much product pushing, and a lack of transparency with clients. Let’s take a look at how robo-advisors address these concerns and try to solve them.
High barriers to entry
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Traditionally, financial advisors require fairly significant assets to begin working with a client. A human advisor likely won’t work with an individual who has less than $250,000 in assets. A robo-advisor doesn’t judge you on the size of your balance sheet, in some places, like Acorns, you can start investing with just a couple of cents!
High Fees
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A traditional advisor charges a management fee of 1-2% per year. In addition, they may recommend mutual funds or other investments that carry additional high fees and eat away at your profits. Robo-advisors, however, charge fees of about 0.25% annually. This lower cost means you get to keep more of your investment earnings!
Product Pushing
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Over the years, many people have felt swindled and misled by their advisor because they are being recommended products that don’t necessarily jive with their financial goals, but that earn the advisor a good commission. Sometimes, a financial advisor may come off as a salesperson, trying to get you to buy something you don’t really need. Robo-advisors don’t really offer a ton of diversification, they rely on an algorithm to analyze your information and recommend an asset mix that aligns with your goals. In the end, however, they only have a fixed pool of investments to choose from, they can repackage those investments in various ways, but they don’t really stray from their one core product (at least not yet).
Lack of transparency
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Financial advisors sometimes get a bad rap for not explaining to their clients what their investments are or how they work. Sometimes, trying to explain a complicated product to someone with minimal knowledge, can be difficult and time consuming, which is why robo-advisors keep it pretty simple. Popular robo-advisors, like Betterment, Wealthfront, ElleVest, Stash, and Acorns, provide lots of insight into what ETFs they use and engage their users with newsletters and supplemental resources to help them with their financial literacy.
All in all, robo-advisors have made investing accessible and significantly easier for everyday people. There are a lot of advantages to starting to invest early, and these companies make that possible. It doesn’t mean there aren’t some drawbacks, or that using a human advisor later in your financial life is pointless, but it does mean you can get started now and improve your balance sheet and your investing knowledge as you go! Remember, each robo-advisor has a slightly different approach and/or interface. If you’re ready to start investing, even if it’s just with your spare change, we recommend you take a look at each one mentioned and decide which is best for you!
