The Robo-Advisor Phenomenon

The Robo-Advisor Phenomenon Recently one of the more popular investing strategies has been to utilize one of several so-called “robo-advisors”. What is a robo-advisor? It is not actually …

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The Robo-Advisor Phenomenon

Recently one of the more popular investing strategies has been to utilize one of several so-called “robo-advisors”. What is a robo-advisor? It is not actually an advisor at all, but instead an algorithm that chooses how to invest your funds, based on information you give when you sign up. Although more and more companies are offering this as a form of financial advice, there are two juggernaut companies that paved the way for this phenomenon, Betterment and Wealthfront, and this review of Wealthfront explains the program’s key characteristics in much greater detail. Here, we will discuss the general pros and cons of investing with a robo-advisor.

 
Benefits of Investment Programs
 
The main perk of using a program rather than a person is taking out the human element. Although a person can intervene and take out his or her money at anytime, the robo-advisor program allows a person to bypass the number one reason individual investors’ returns lag the market by simply not touching the account. Everything is completely automated; when signing up, the systems will ask some basic assessment questions, and will then create and stick to a portfolio based on the individual’s risk tolerance. With a human advisor, it becomes a bit trickier to come up that perfect asset allocation model. Additionally, it becomes much easier to fall prey to the constant trading problems that can befall a portfolio.
 
Potential Disadvantages
 
On the flip side, not having an actual person monitoring the account can result in devastating losses. Almost everyone lost major amounts of money in 2008, when the S&P 500 lost 37%. Some investors, however, were lucky enough to sell off most of their funds before the Great Recession really hit, due to savvy financial advisors. Even better than those people were the people who almost sold their portfolio at the depths of the market’s recession, but held firm because of their advisor’s advice, causing them to not miss out on the subsequently long bull market. Robo-advisors were unable to prevent their clients from making this crucial mistake.
 
Investor Fees
 
Another pro of robo-advisors are the low fees. Both of the aforementioned companies do not charge fees for individual trades like brokers do. Instead they charge a small management fee of 0.15%-0.35%. Most money managers charge at least 1% just in management fees. This makes sense, paying more to a human who needs to eat than to a program that runs automatically. Still, the hit to a portfolio when that extra 0.75% is taken out every year can really hurt a retirement portfolio.
 
Account Types
 
Depending on the type of account, one of the biggest claims of the robo-advisor industry could be a big advantage, or completely moot. Personally, my investment with my robo-advisor of choice is in a traditional IRA, so tax loss harvesting does nothing for me, as I am not currently paying taxes on the account whatsoever. For those with non-qualified accounts, though, automated tax loss harvesting can be a big benefit. Every year when you go to pay your taxes, you pay both ordinary income tax as well as any capital gains taxes you may have had. However, realized capital losses (realized meaning you actually sold the position) allow you to offset any capital gains, and use some to offset some ordinary income as well. Robo-advisers will make sure to take care of selling the losses to offset potential gains for you, so you do not need to make the calculations or trades.
 
Conclusion
 
Robo-advisors have been growing in popularity steadily since they came into existence. Betterment has even won a Nobel prize for their investing algorithm. Just because something is popular or awarded, though, does not make it right for everyone. Some people feel more comfortable dealing with a human being, and are willing to pay the premium for it. There are many reasons to decide to utilize a robo-advisor, but also several reasons to invest with an actual financial advisor. Make sure to conduct your own due diligence, and make the decision that is best for you.
 

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