Until recently, the investment world has been very different. Human financial advisors used to be in complete control of the investment portfolios. Today, this absolute dominance is shared with a new player in the market—the robo-advisor.
But what are robo-advisors, and are they right for you? Let’s venture into the realm of robo-advisors and check out their growth, meanwhile helping you decide whether they are a good fit for your financial journey.
Table of Contents
What Are Robo-Advisors?
Robo-advisors are digital platforms that offer automated algorithm-driven financial planning services with little or no human supervision. In simple words, these are digital financial advisors that manage your investments with the help of technology.
You do not have to meet a person or make that call.
Instead, you answer some questions about your financial goals, risk tolerance, and time horizon, and let the robo-advisor do the rest.
These websites utilize sophisticated algorithms in building and managing diversified portfolios in keeping with one’s needs. They are kept updated and rebalanced to keep your investments in line with your goals. Pretty cool, isn’t it?
The Rise of Robo-Advisors
The robo-advisor market has grown extremely fast since it was founded back in the late 2000s. The very first robo-advisor to launch was that of Betterment, which launched back in 2008 and blew up since then.
Today there are tens of robo-advisors one can choose from which manage billions of dollars in assets. But why do robo-advisors suddenly pop out of nowhere? Here are a few reasons why that is:
- Accessibility: With robo-advisors, investing has been made open to all. You don’t have to be a millionaire before you start investing. Many robo-advisors grant users low or no minimum investment, thus making it very approachable.
- Low Fees: Traditional financial advisors often charge high fees that eat into the returns on your investment. Most robo-advisors, on the other hand, charge low fees. This is because they deploy technology to automate a great deal of the work that a human advisor would do.
- Convenience: With a robo-advisor, you can handle your investments from the comfort of your own home. No need to set up meetings or make any calls whatsoever. It is all done online, and you can check your portfolio at any place, at any time.
- Personalization: Even as automated platforms, robo-advisors give a very high degree of personalization. They take your answers to a series of questions and construct a portfolio that’s right for you and your goals.
How Do Robo-Advisors Work?
So, how do robo-advisors really manage your investments? It starts with a questionnaire. You open up an account with a robo-advisor, you answer a series of questions about your financial goals, risk tolerance, and time horizon.
Based on your answers, the robo-advisor will construct a diversified portfolio of usually low-cost exchange-traded funds, or ETFs. With your portfolio set up, the robo-advisor will then monitor and, where necessary, rebalance it.
Rebalancing refers to making changes to your portfolio so that it maintains its chosen level of risk. It does this by shifting the composition of a portfolio back to the mix set when an investor signed on, which could be altered over time.
That is, if part of any one investment in your portfolio happens to do extremely well, for instance, it could comprise a far greater part of your portfolio than you had set.
At such a point, the robo-advisor will automatically sell some of that investment and purchase more of another to bring your portfolio back in line with your goals.
Are Robo-Advisors Right for You?
Now that you have learned what robo-advisors are, and how they work, the million-dollar question is: are they right for you? It depends on your individual needs and preferences. Here are some things to consider:
- Your Investment Knowledge
If you are new to investing – or don’t have the time or desire – to manage your own portfolio, a robo-advisor might be a very good choice.
They take the guesswork out of investing and provide a hands-off approach. However, if you are an experienced investor who enjoys picking stocks and managing your own portfolio, you might like handling investment matters on your own.
- Your Financial Goals
Robo-advisors are targeted toward long-term financial goals, such as retirement savings or buying a home.
If you have individual short-term goals, or if you want more personalized financial advice, then you might want to stick with a human advisor.
- Your Budget
Perhaps the most significant benefit of the robo-advisor is the cost. If you have an extremely tight budget, or if you’re just getting started, a robo-advisor can provide professional investment management at merely a fraction of what a human advisor could charge for the same service.
But if you have a much larger portfolio and can afford paying for personalized advice, that human advisor is worth the extra cost.
Use our Home Loan Calculator to better estimate your affordability if you’re considering buying a home.
- Your Comfort with Technology
Robo-advisors are entirely online, meaning that one has to be comfortable with using technology to manage their investments.
If you prefer face-to-face contacts or aren’t comfortable with online platforms, take the traditional advisor route.
Pros and Cons of Robo-Advisors
Let’s look at some pros and cons of using a robo-advisor.
Pros:
- Low Fees: Usually, robo-advisors charge lower fees than traditional financial advisors.
- Accessibility: You can start investing with less money.
- Convenience: You manage your investment online anytime and anywhere.
- Personalization: A portfolio tailored to the customer’s goal and risk tolerance.
- Automatic Rebalancing: The portfolio will always be in tune with a set goal.
Cons:
- Limited Personalization: Even with their capacity for personalization, robo-advisors cannot provide specific advice compared to human advisors.
- No Human Interaction: If face-to-face interaction is preferred or a person seeks more personalized advice, then a robo-advisor isn’t the best fit.
- Limited Services: The services offered by robo-advisors are typically related to investment management and may not offer other services regarding financial planning, such as tax planning or estate planning.
Conclusion: Is a Robo-Advisor Right for You?
The newness of the robo-advisors has brought a whole new dimension to investing: more approachable, more affordable, and just generally easier than it’s ever been.
They are a great option for investors who are beginning to invest, are on a tight budget, or would simply like to take a more passive approach to their investments.
Yet, they may not be the ideal solution for every investor.
If you’re tech-savvy, have a long-term financial focus, and seek an affordable way to manage your investments, then a robo-advisor may be the best route for you.
However, if you require more personalized advice, if your financial needs are complex, or if you simply prefer working with a human advisor, you should reconsider your options.
It is all about what works best for you. Take some time to weigh the options, and choose the pathway that’s right for you.
Happy investing!
