Robo-advisors might not be as inherently exciting as the 1966 Western Classic starring Clint Eastwood, but they are certainly more modern. Forty-two years after the debut of this Eastwood blockbuster, the first Robo-Advisor came onto the scene.
Eleven 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
What Is A Robo-Advisor?
Robo-advisors strutted onto the scene in 2008, like how Tom Cruise struts away from explosions in almost every movie he is in.
Or is this case, bikes away.
During a global recession, the first robo-advisor was created in 2008. 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 of 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 very easy and straightforward. They revolve around either getting:
- Personal Details: 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, answering these basic questions and letting a robo-advisor do the rest is 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.
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. So, if 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, if you are invested in a broad index fund that drops 10% one year, then 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 required (though, it usually comes with an added cost).
Last, but not least, is the fund selection within robo-advisors – most of the time, it is an excellent selection.
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 is not 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, but they don’t have nearly the full selection 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.
You’re locked into their plan, for better or worse.
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.Our horses are tired. Our guns out of ammo. Our 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. This, of course, varies by company, but it’s a good rule of thumb and average.
This means that for every $10,000, the robo-advisor manages. They charge $25. This is how they 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.
This is 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)?
How To Get Started With Robo-Advisors
In my opinion, robo-advisors can often be worth the cost. Especially for new investors or for someone who wants to take a hands-off approach.
As we mentioned, getting started with robo-advisors is easy. Two of our favorite robo-advisors are discussed below, each good for a specific part of your portfolio.
Betterment launched in 2010 and was one of the first robo-advisors to explode on the scene. They state their mission is to “Help People Live Better.” It’s a little corporate-y. But they certainly live up to it by providing best-in-class investing resources to the masses.
Betterment works the typical robo-advisor (as described above). New investors answer a short series of questions to allow Betterment to set up and manage their investments ongoing.
It’s a very hands-off approach for investors. This makes it great for new investors or those who don’t want to spend a lot of time worrying about reallocating their portfolio or optimizing it for taxes – Betterment does it all for you.
Betterment also works on various individual accounts, from personal brokerage accounts to Roth IRAs.
Blooom is a robo-advisor designed explicitly for 401(k)s.
It was started a few years ago by a couple of Wall Street guys… but don’t let that scare you away. They founded the company because they were fed up with Wall Street and what they were currently offering (or not offering) to the everyday investor.
But here, take it straight from them (the video is 3 mins and worth a quick watch):
So Blooom was created, and provides two main offerings:
- Free 401(k) Analysis
- Ongoing 401(k) Management
Free 401(k) Analysis
Blooom can connect to your 401(k) to review your account and provide actionable tips on how to optimize your 401(k).
- Price: Free.
- Expense Ratio: None. No hidden fees.
- Account Minimum: $0
- Services: 401(k) analysis, which provides:
- Diversification recommendation.
- Fee check-up – ensuring you are in the lowest fee funds possible.
- Other watch-outs, like being invested in company stock.
- Retirement tracking snapshot – to help ensure you are investing enough in your 401(k).
Ongoing 401(k) Management
Blooom also offers ongoing 401(k) management, so you can take a more hands-off approach and let them take the wheel. This service is similar to what Betterment and other traditional robo-advisors do.
- Price: Flat $10 / month.
- Expense Ratio: None. No hidden fees.
- Account Minimum: $0
- Services: 401(k) management, which provides:
- The free analysis detailed above.
- They are automatically investing you in the right funds based on your risk profile and goals.
- Rebalancing your 401(k) ongoing, ensuring that you stay on track for retirement.
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
Investing on your own will always be the most affordable way to invest. It’s also the most time-consuming.
If you want to get started on your own, you can check out this complete guide to index investing for beginners.
Hiring A Financial Advisor
Hiring a financial advisor is expensive, and not often recommended by me, but it is an option nonetheless.
A financial advisor is typically more expensive than a robo-advisor and is undoubtedly more costly than investing on your own. Though, for more complex personal finance needs, they can help take some of the stress out of managing your money.