What Exactly is a Robo-Advisor?
I’m a part of that 10 percent. I decided to hop on the bandwagon for my initial investments and signed up with Betterment.
It took me a little while to figure out the whole process, but after a while, it seems pretty simple. Here’s how robo-advisors work:
- financial goals,
- investment objectives,
- risk profile
- financial circumstances
If you want to work with a robo-advisor, it helps to have all this mapped out. Since I was new to investing, I didn’t. Luckily, the app (and a little research) helped me figure out my answers to those questions.
Then the robo-advisor produces an asset allocation solution based on Modern Portfolio Theory (MPT) or Efficient Market Hypothesis. Most robo-advisors invest in low-cost exchange-traded funds (ETFs).
The level of human interaction varies among robo-advisors varies from none at all to minimal to moderate. A few of the larger robo-advisors, such as Betterment, Personal Capital, and Vanguard offer clients the opportunity to speak with financial advisors as part of their service.
Robo-advisors generally charge a percentage fee based on assets under management ranging from 0.25 to .89 percent. That’s cheaper than most human financial advisors, whose charges often range from 1 to 3 percent.
The robo-advisor’s fee includes portfolio management (using one of their model portfolios), tax harvesting and rebalancing. Minimum deposits range from zero up to $100,000. Many of the top robo-advisors offer tiered services with lower fees for larger deposits.
Betterment didn’t have a minimum deposit (I chose the Digital account option), and my fee was 0.25 percent (I’m not reaching $100,000 anytime soon).
Why Consider a Robo-Advisor?
That may be due to a lack of understanding. Because robo-advisors are still new, many people still don’t understand them very well. Of the millennial investors who don’t use a robo-advisor, more than two-thirds either don’t know enough about them or don’t understand the way they work.
When I started, I didn’t know much either, but I thought it was easier to learn through a robo-advisor than a human advisor.
On top of that, the time commitment to courting and meeting with a financial advisor just wasn’t doable for me. It was much easier to rely on the app. I felt that I could also invest small amounts without feeling embarrassed or pressured to invest more (not saying all advisors would do that, but some do.)
Because robo-advisors are based on complex algorithms, they can take some of the emotion and emotional mistakes out of investing. They tend to be able to execute rebalancing and tax-loss harvesting strategies more easily than most human investors can.
If you are a bit of a micro-manager, then a robo-advisor can make even more sense. A financial advisor could be too busy to take your calls if you have questions. A robo-advisor, on the other hand, is always at your fingertips. If you see something that you need to look at and take action on right away, all you need to do is whip out the phone and go for it. You can monitor and adjust your investments with ease.
Yeah, that won’t work for me. Earlier I mentioned that I liked how I could invest smaller amounts. This may be due to the fact that I’m nowhere near ready to invest a quarter million.
The Advantage of a Robo-Advisor for Regular Periodic Investing
Robo-investors are a great starter investment. You can start with no assets and as little as $25 a month and still have access to automatically-generated personal financial advice to guide your decisions.
Investors who choose to transfer a portion of their paycheck into a robo-advisor account can also benefit from dollar cost averaging (DCA) – an investment method that takes advantage of systematic contributions and the fluctuation of prices in the market. With DCA, a fixed dollar amount is invested each month (or however often you get paid). That amount buys a certain amount of shares based on the current share price.
For example, if you invest in an exchange-traded fund (ETF) that is currently selling for $10 a share, a $250 contribution will buy 25 shares. If the ETF share price drops to $8 a share in the second month, the same contribution will buy 31 shares. If the price increases in the third month to $12, it will buy 21 shares.
At the end of three months, you will own 76 shares currently worth $912, but you will have only invested $750.
With DCA, you buy more shares when the price drops and fewer shares when the price increases. You just have to keep investing, regardless of what the market is doing on a given day.
As long as the market continues to rise over time (which it has for more than 100 years), your cost basis will be lower than the current value of your shares.
Using A Robo-Advisor to Build Your Wealth
As you can see, a robo-advisor is a great way to start investing and building wealth. You sign up and invest regularly. You do that for enough years and you will have plenty of assets.
If you still want to work with a human advisor, you’ll be able to afford to do so. But by the time you’ve built enough wealth to consider changing your asset management, you may also have gained the knowledge and familiarity with investing to manage your own portfolio.
Or you may just continue working with a robo-advisor. Their algorithms are designed to adjust your investments even as your life and the economy change. Meanwhile, you enjoy low-fee, diversified investing and a brighter, more financially secure future.
So if you’re just starting your investing journey, take a look at a robo-advisor. It might be just the right way for you to get started on your wealth-building journey.
Have you used a robo-advisor? What are your thoughts on robo-advisors, or better yet, your experiences with them?