Robo-advisers are cost-effective, simple but suffer from myopia
One of the building blocks of growing wealth is smart investing. My mom was a high-school teacher and guidance counselor and realized in the early 1980s that to build wealth she needed to invest in the stock market. This was at the advent of no-load mutual funds. She began reading about investing and researching different alternatives. She wasn’t comfortable investing in individual stocks and invested directly in the emerging no-commission mutual fund products.
She loved simplicity and would have loved the advent of robo-advisers.
Robo-advisers made their debut in 2008. These are automated digital platforms that use computer algorithms to manage investment portfolios. Advantages include a diversified portfolio, automated rebalancing and tax-loss harvesting. And they are noted for their low-cost approach. They are characterized by low or no-account minimums, are easy to get started and have a set-it-and-forget-it mentality.
To be cost-effective, robo-advisers rely heavily on computer algorithms and a variety of standard financial models to deliver well-diversified portfolios. Each provider uses different algorithms, investment strategies and portfolio models. Most platforms start with an in-depth questionnaire to assess your current financial situation, time horizon, risk preference and ability to handle volatility. Based on your investing personality, you are directed to a portfolio model that would meet your needs. Your portfolio is then monitored and adjusted based on market trends and economic indicators. This algorithmic approach removes human biases and emotional responses that could lead to poor investment decisions.
A robo-adviser can be a good option for those who are new to investing, have limited funds to invest, prefer a hands-off approach to investment management, and are comfortable with a digital platform and minimal human interaction. They are most appropriate for long-term investors who favor a generally passive indexing approach.
Robo-advisers have many good qualities, but they are not without drawbacks. Their automated approach leaves little room for adaptability or specificity that comes from working with traditional financial advisers. They tend to provide cookie-cutter products that rely on the same basket of underlying funds, thus limiting access to the full range of investment options. They do not take into consideration funds invested outside of their platform, so they don’t have a complete picture of your overall investments.
The algorithms are not able to identify the nuances of individual circumstances or make prudent judgment calls based on complex situations. While some platforms allow you to adjust time horizons for planned life events, unplanned events are not able to be addressed. There are some platforms that have added the capability of a human touch, but their ability to address the depth and breadth of a situation is limited. The human advisers are also not able to make direct adjustments to your underlying portfolio.
If choosing to use a robo-adviser, know that not all platforms operate with the same parameters. Some are designed for meeting straightforward investment objectives, while others might provide some personal guidance, more detailed initial intake and flexibility. Each platform is driven by the underlying data assumptions and the quality of the algorithms used. The initial input questionnaire may might be as comprehensive or relevant as others and might point to a different investment solution for individuals with similar profiles. One other drawback is that frequent trading might lead to more taxable activity. Fees also vary among providers and levels of service.
Robo-advisers might work for a large section of investors, but individuals with complex situations who are going through difficult transitions or want personalized service might find their offerings limited.
As with everything in the financial services industry, there is no one correct solution. Understanding your unique situation, goals and needs might lead you to a different solution than that of your neighbor, co-worker, family member or friend. Work to educate yourself about the various options available and do your due diligence to find a solution that works best for you.
~Jalene
