Robo-advisors can invest and perform basic money management functions for consumers today at a fraction of most human advisors’ costs. But for all they can do, robo-advisors have their limitations—there are still many functions that only a human can do.
Here’s a breakdown of what robo-advisors can and can’t do for you at this point in their evolution.
Key Takeaways
- Robo-advisors automate investing and trading strategies at reduced costs.
- Robo-advisors cannot understand or implement complex investing strategies or create customized financial plans.
- If you’re getting started investing, it might be best to use the services of a financial advisor to help you understand strategies, terms, and ways to invest.
- The financial services industry is working to increase the abilities of its robo-advisors.
What Robo-Advisors Can and Can’t Do
Robo-Advisors Can
Reduce the cost of frequent transactions
Automatically rebalance your portfolio
Keep you updated on your account activity
Frequently apply tax-loss harvesting
Robo-Advisors Can’t
Understand your individual concerns
Provide personalized advice
Create complex financial plans
What Robo-Advisors Can Do
When it comes to making logical financial decisions and performing routine money management chores, robo-advisors are excellent tools to help you stay on track and maintain your initial portfolio allocation over time.
Reduce the Costs of Frequent Transactions
Most robo-advisors are designed to follow Modern Portfolio Theory, balancing risk with reward. One of their greatest advantages is that they can perform all of these functions at a very economical cost. Most programs only charge a fraction of a percent for their services and, in some cases, are even free—depending on the amount you put into your account. These types of portfolios are designed so that you can effectively set it and forget it.
Automatically Rebalance Your Portfolio
Robo-advisors can easily perform dollar-cost averaging and portfolio rebalancing.
This type of algorithmic trading has been around for more than a decade, but it didn’t enter the mainstream market until after 2008, when platforms such as Betterment and Wealthfront entered the arena. These robo-advisors allow even novice investors to create a portfolio based on their risk tolerance, time horizon, and investment objectives. You only need to answer a few questions posed by the program that tells it what you want it to do with your money.
Rebalancing a portfolio can trigger capital gains taxes and incur transaction fees. Make sure you ask about fees and tax-loss harvesting when you’re looking for a robo-advisor.
Keep You Updated on Your Investing Activity
Once you have answered the program’s questions, the robo-advisor will select a group of investments matching this information. You can then monitor the portfolio anytime by logging in to your account.
Tax-Loss Harvesting
A robo-advisor can be programmed to apply automated tax-loss harvesting strategies to your portfolio. Tax-loss harvesting is the process of selling investments that have incurred a loss to offset capital gains on investments that have incurred a gain. This can be a cost-effective tax-planning strategy for some investors.
What Robo-Advisors Can’t Do
Robo-advisors do present some limitations despite their technological sophistication. Of course, the most critical element that they lack is human interaction, and there is no substitute for this in some cases.
Understand Your Concerns
A robo-advisor can create a portfolio based on your input into the program. But what if you sustain a loss and decide to change the entire portfolio based on that single event? This is where a human advisor can work with you to overcome your fear of loss, stay the course with your current portfolio, and not go off track in your long-term investment plan.
Provide Advice
Although they can create personalized portfolios, even the best robo-advisors can’t necessarily provide customized advice based on your preferences or life situation if you can’t input those factors into the service. Many of these programs may not be able to screen out certain types of investments that go against a client’s beliefs, such as alcohol, tobacco, or fossil fuel stocks. However, many brokerages are changing their robo-advisors to include socially responsible investing options.
Brokerages are working to find more ways for users to customize their robo-advisor experience by adding more services. For example, Betterment, one of the first robo-advisor platforms, has portfolios for investors interested in cryptocurrency.
Robo-advisors can’t tell if you are unsure of what you want or are unable to answer the questions it poses because your situation may be unique. They don’t have the skills to talk to you about the features or benefits of a product or service or about a poor decision that you could be making.
Robo-advisors can only make generalized decisions regarding portfolio allocation. They cannot dispense tax or legal advice and won’t keep their clients updated on the latest tax information or estate planning strategies.
Create Complex Financial Plans
Robo-advisors lack the ability to do complex financial planning that brings together your estate, tax, and retirement goals. They also cannot take into account your insurance, general budgeting, and savings needs.
While there are computer programs that can provide financial planning, they generally still require data entry from a professional who understands how to enter the numbers so that the program can make the necessary calculations to produce an accurate plan.
What It Means for Investors
Robo-advisors will continue to grow more sophisticated as time goes on, but there are some aspects of financial planning that only humans can do. If you’re new to investing and have a more modest portfolio, these automated services may be a low-cost alternative to a more expensive alternative.
But if you have a larger portfolio with more complex requirements, then it might be best to use a human financial advisor or a hybrid robo-advisor and human financial advisor.
Can You Lose Money with a Robo-Advisor?
Robo-advisors are much quicker to respond to changes in your assets, but they are not able to predict market outcomes. It is just as possible to lose money using a robo-advisor as it is using a human advisor.
How Much Does a Robo-Advisor Cost?
Generally, you’re charged a small percentage for assets managed by a robo-advisor, but it varies by brokerage. For example, you might be charged 0.25% to 0.50% for every $1,000 managed. For smaller accounts, some robo-advisors will charge a monthly fee of about $3 or $4 per month.
What Types of Investments Do Robo-Advisors Invest in?
Most robo-advisors build portfolios using exchange-traded funds (ETFs). They are programmed to select ETFs that offer exposure to a variety of securities, making it easy for the robo-advisor to build a diversified portfolio and to hit a specific asset allocation.
How Do Robo-Advisors Choose Your Portfolio?
Robo-advisors choose the type of portfolio to build for you based on many factors. When you sign up for an account, you’ll typically answer a series of questions about your age, financial situation, time horizon, risk tolerance, and goals. The robo-advisor then uses that information to come up with a portfolio that an algorithm has determined will best fit your needs.
The Bottom Line
Robo-advisors can help automate investing, removing the emotion from the process. They can help design a portfolio, maintaining the right asset allocation, and allowing you to set it and forget it. They can also assist with more complex strategies like tax-loss harvesting.
However, robo-advisors are not human and can’t provide some of the assistance and flexibility that a human advisor can when it comes to designing a holistic financial plan. Consider whether your situation is complex enough to require a human touch or if you need more hands-on assistance before deciding whether to work with a robo-advisor.
