Last Updated: August 31, 2021
In case you were wondering:
Can modernizing investment strategies bring you financial success? And, are robo-advisors worth it?
Well, whether you like it or not, robots are here!
The first fully robotized hotel in Japan, Henn-na, is successfully running since 2015. In that futuristic sanctuary, robots are in charge of everything. They clean the windows and serve your first cup of coffee in the morning.
Robots aren’t the future, they’re the present. Even automated investing along with high-frequency trading is old news already. Believe it or not, the first robo-advisor has already turned 13.
The world of financial planning and investments has entered a new era. Since 2013, when Nobel Prize winners Fama, Hansen, and Shiller have set new cutting-edge standards in economics, robotized management has been growing in popularity.
Still, some people are skeptical when it comes to fully trusting their finances to robo-advisory services.
For that reason, we will explain how robo-advisors function as well as weigh the pros and cons of the technology. Additionally, we will give you the latest insights on the subject. All this should help you conclude whether it is worth switching to this investing method.
What Is a Robo-Advisor?
Robo-advisor is an automatized financial advisory platform that works on the principle of algorithmic data sorting. It is a program that suggests your next business move based on your financial potential and preferences.
Having a robo-advisor is very similar to having a financial advisor in terms of investment strategy, minus human touch. The main difference stems from the fact that robo-advisors don’t offer investing advice. However, some robo-advisory companies have already gone a step further, offering additional human advisory services at an extra cost.
This convenient financial engine assures:
- greater data storage
- quicker access to information
- a higher number of combinations than any human could ever provide
While the technology itself has been there for a while, it only became available for broader usage in 2008. Initially, only the leading human wealth managers could afford an automated financial advisor. So, it went from being the exclusive privilege of top-tier professionals to an easily accessible tool available to nearly everyone. This state-of-the-art automated investing assistance has already come a long way.
How Do Robo-Advisors Work?
You may be used to the conventional methods of managing your assets and transactions. However, those methods are slowly turning obsolete. So, the same way you can’t imagine doing complicated mathematical operations without a calculator, some more progressive investors can’t imagine managing their operations the old-fashioned way.
Now, how do the financial robo-advisors work?
Quick sign up
One of the main reasons why investors decide to try robo-investors is their hustle-free sign-up systems. Within as little as 10 minutes, you can be all set to start. As a comparison, it might take you ages to find a competent, reliable, and dedicated advisory agent.
Building a strong automated portfolio
Once you sign up, you’ll have to complete a straightforward questionnaire. The information you provide will be used to create an automated portfolio and set up your investment goals.
The questions have been carefully chosen by renowned experts from the fields of economics and psychology. They help determine your financial aspirations, risk- tolerance, potential, and limitations. That means that a comprehensive robo-advisor portfolio is already available at this stage.
Portfolio updating and rebalancing
Robo-advisors are based on modern portfolio theory (MPT). That means they are working on maximizing your anticipating return by constantly improving your portfolio (measuring the ongoing market risks).
The system updates regularly, and it automatically rebalances your account whenever necessary. With every transaction you make, starting with your first one, the algorithm recalculates and comes up with new possibilities for you.
So instead of having to make several appointments with your financial advisor and waste your time, a robo-advisor has it all covered for you. You can rest assured that your automatic robo portfolio management is always working for you.
Easy information access
One of the main principles on which robo-advisors work is the accessibility of all the essential information. Instead of referring to different agents, books, and paperwork, you can refer to your robo-advisor mobile or web application and get all the necessary details. And this is possible in only a few clicks.
In addition to having access to all the transactions and your investing history, you get the added benefit of learning new tricks and widening your business horizons. Well-established robo-advisors such as Betterment have an extensive database that includes educational and informative content and tools. It’s a great feature and can significantly ease the investment for beginners.
Depending on your robo-advisor’s package, you can get various additional services, of which some are even free. What all of them have in common is that they all work towards improving users’ experience. Not to mention the added financial bonuses that come along. The most common additional features are:
- Tax-loss harvesting — some robo-advisors can predict stock market changes and help you avoid high taxes. By timing transactions so you sell shares at a loss, they are offsetting the gains you get from selling other stocks at a profit. Since you are only paying taxes on your net profit (the amount you’ve gained minus the amount you’ve lost), you are reducing your tax bill.
- Financial advice — although the main idea behind robo-advisers is reduced human activity in investment management, there’s no reason to completely eschew human contribution. So if you feel like you need in-person advice, you can request to get one.
- Borrowing services — some robo-advising platforms offer loans that are faster, easier to get, and have lower interest rates than regular bank loans.
- Saving services — robo financial planning most of the time includes saving services. So, if you are not as good at saving as you would like to be, don’t worry, most robo-advisors have additional saving options. They set aside all the extra money from your regular transactions, turning it into savings.
- Retirement plans — those who wish to ensure a safe future can choose between various personalized retirement plans. Most robo-advisories have this useful feature.
Pros and Cons of Robo-Advisors
Now, if you still can’t decide:
Should I use a robo-advisor or not?
As practical as robo-advisors may sound, they aren’t perfect — no platform is. That’s why it’s essential to stay objective and carefully compare their advantages and drawbacks. It’s the best way to decide if you want this system of financial management and, ultimately — are robo-advisors worth it for you?
Let’s first take a look at the most prominent reasons for considering robo-advisors worth your try.
Quick and stress-free enrollment
This is an ideal option for potential investors who always wanted to join the market but never had the courage to. Quick and stress-free enrolment, as opposed to a tiring search for a personal advisor, is a significant advantage. And the best thing of all — no hard feelings since robo-advisors can’t get disappointed at you for changing your mind about enrollment.
Excellent for beginners
A low initial level of involvement, straightforward instruction, and clear actions can be very attractive to beginners. Next, one of the biggest benefits of robo advisors is the profiling that is done at the beginning, as it can help you discover your investing tendencies and potential. Finally, additional tools and information databases that come along can replace months of research. All in all, it’s a learning experience worth considering.
No minimum investment sums
Investors with a modest net worth will be relieved to hear that most robo-investors do not have a lower limit for the account balance. You can start with as little as a few dollars in investments. What’s more, some robo-advisors like SoFi and Ellevest offer promotions and trial periods during which users don’t have to pay any fees.
Quick and easy to grasp
The best automated investment services are programmed to be streamlined and easy to follow. Simple yet effective management strategies like investing 60% of assets in stocks and 40% in bonds are common. In other words, you don’t need to spend hours trying to understand how things work. You can relax and ease yourself into the process.
Have you ever tried to calculate how much time you spend waiting in lines to get a piece of decent advice?
Also, have you ever tried to convert that time into money worth?
How much money would that be?
Probably a lot!
However, with a reliable robo-advisor, there is no waiting. Some of the best robo investment advisors are available and ready for use at all times.
So, instead of losing money while waiting for your broker to return your call, with a robo-advisor, you can earn on the go, anywhere, anytime.
Tailored investment plans
Whether you are into socially responsible investing or you are simply looking to create a standard portfolio, robo-advisors make it all possible. Nowadays, the system is so well-developed that numerous robo-advising companies offer multiple plans to choose from. Instead of relying on investment agents that can be subjective and are often biased, robo-advisors offer a more objective and tailored approach.
We will discuss robo-advisor fees in detail later on in this article. But, let’s just say for now that one of the standing-out advantages of automatized management is that they are cost-effective.
On the other hand, robo-advisors have some shortcomings which one shouldn’t take lightly. Examine carefully to what extent would these weak points disrupt your investing ambitions before you decide whether robo-advisors are worth it.
Whether this belongs on the pros or cons list depends on one’s attitude, but we could say that robo-investing promotes the every-man-for-himself approach.
Unlike having an actual investing advisor who can include diverse ideas from his office and his colleagues, there’s not much human-to-human interaction with this type of investment management. And, whenever the other person’s advice is possible to get, it usually comes with the added costs.
So, aside from expensive supervising agents, it is pretty much you and your mobile or web application, most of the time.
Lack of personalized content
Whether we liked it or not, our needs as human beings go far beyond the mathematically precise solutions. And although relying on algorithmic calculations can often bring better results, it might exclude other important trading factors.
Keep in mind that your robo financial advisor, as accurate as it is, can never boost your confidence like your human financial advisor would. Sometimes aside from logical suggestions, we need that pat on the back or a slight push to finalize our goals. Robo-advisors are, unfortunately, still lacking in this aspect. They might suggest some of the best hands-off investing ideas, but it is solely on you whether you’ll have the courage to accept them.
Limitations in robo-advisor returns
If you are looking for a way to beat the market instead of gaining profit from it, you are at the wrong place. Robo advisors are not created to beat the market but to work in synchronicity with it as much as possible. This puts some limitations on how much you can actually earn.
Being consistent in high returns, despite the market fluctuations, requires a gifted and fully dedicated human or team of experts to handle. It’s not the type of management that an automated platform could likely achieve.
It’s possible to cover fees for the robo-advising services either through regular monthly payments, or more commonly, assets under management (AUM) percentages. The latter means that you are only paying fees when your listed assets increase under the robo-advisor’s management. In both cases, your expenses are minor, especially in comparison to those of physical advisor services.
To support this statement, we will compare the minimal expenses of humans and robo investment advisors.
Before robo-advisors became an option, the cheapest investment advising services could rarely cost less than 1% of the assets. With robo advising technology replacing human experts, the advising fees can go as low as 0.25% (Betterment) or even free (Charles Schwab).
Among the more expensive options are the robo-advisor firms that charge a 0.50% fee but offer higher robo-advisor returns. Also, the fee will vary depending on the amount you are investing and the type of service you are opting for. However, there are many service providers like Wealthfront that have services tailored for cost-conscious users.
Keep in mind that some of the additional services, such as personalized advising, can significantly add to your total expenses.
It would be quite difficult to give precise statistics on human advisors’ performances over the years. Robo-advisors, on the other hand, are much easier to track.
Let’s now take a look at how the top five robo-advisors have performed over the years before you can answer this question.
One of the pioneers in the field and among the best investment platforms for beginners still hasn’t lost its place among the leading robo-advisory platforms.
With its fairly low fees (0.25%–0.40% depending on your investment plan) and no minimum investment required to join, it remains attractive to investors of various profiles.
Betterment data from January 1, 2004, to March 17, 2020, shows that the average yearly return was 8.2%. Of course, there will always be ups and downs, but these positive overall results are here despite the 2008 economic crisis and over four years of drawdowns greater than 15%.
The highest return was noted at the beginning of 2010, with the approximate 30% return in 75% stocks robo-advisor portfolio.
All in all, Betterment has shown great resilience ever since it was launched in 2004 with its lower than average drawdowns and its higher than average returns in the long run.
Acorns is among the top robo-investing platforms that specialize in micro-investing.
As opposed to previously mentioned robo-advisors, Acorns has fixed monthly fees that can be as minute as $1–$5 a month. There is no account minimum, and the investment management is quite straightforward. Whatever change you are left with from other digital transactions acorns uses it to build it in your portfolio. That is why most of the Acorns reviews refer to it as the perfect saving app.
The long-term yearly return average in a balanced Acorns investment is close to 7.5 %.
Considered the best robo-advisor for goal-oriented investors and particularly popular among the millennials, Wealthfront is always in tight competition with Betterment.
Its average fees for the managing services are also 0.25%, with one difference — the initial minimum investment of $500 is required. This robo financial advisor also offers high-interest checking accounts (with slightly higher fees of 0.35%) and a wide range of low-rate credit products. Wealthfront users automatically gain the right to a line of credit as soon as their portfolio exceeds $25,000 in assets.
The average Wealthfront annual returns are calculated at 7.41% since its initiation. That is a slightly lower return than Betterment has achieved. However, we should keep in mind that these results are constantly fluctuating and that Wealthfront has been active for a shorter period of time (it launched in 2008).
Ellevest is similar to most of the renowned robo-investment services in all except in one trait — it mostly focuses on investment plans for female users.
Its creator, Sallie Krawcheck, realized that it is time for an automated investing advisor concentrating on the pay gaps, career breaks, and longer average lifespans of women. The investment algorithms of Ellevest take into account these significant realities.
There is no minimum account balance, but the membership fees can range between $1 and $9.
The best-robo advisor for ladies collects a slightly longer list of personal information (such as age, location, education, income, marital status, and the number of children). This helps in creating a more personalized plan.
Depending on all these factors and the plan that one opts for, an average yearly return can vary between 6.2–9.8% (expected over 20 years period).
Ally Invest performance
This highly diversified financial platform offers investment plans for all levels of risk tolerance investors.
Ally Invest fees fully depend on the service you’re getting. They can range from no commission (for stocks trading at above $2) to $9.95 (per no-load mutual funds trade).
Ally Invest had significant robo investing returns over the past few years and it gained an impressive value of about $13.4 billion in assets under management. All thanks to almost 406,000 customer accounts.
Robo-advisors vs Human Advisors
To help you decide which investment management method is more suitable for you, let’s quickly go through the final human and robo-advisor attribute comparison. Take a moment to decide which of these feels more in sync with your financial goals.
Robo-advisor vs human advisor: time investment
Robo-advisors are easy to join, easy to use, automatized investment platforms, which means that they are created to save time.
And, while your human advisors may be good at summarizing the key points of investments for you and, therefore, saving your time too, they might not always be available. This can cause significant delays. Besides, with a human advisor your share of involvement and the time investment is higher.
Depending on the type and frequency of the service that you are getting, financial robo-advisors are often significantly cheaper than human ones.
While the robo-advisors fees are easily controllable, transparent, and mostly charge reasonable AUM percentages, human advisors sometimes operate differently. Human advisors usually charge hourly fees on top of the AUM profit percentages. Besides, they can change their rates anytime they feel like, which is not the case with typical robo-advisors.
Still, keep in mind that the additional consulting services with human advisors within a robo-advisor’s program can cost even more than the regular human advising services. So, if you need that human touch to complete your strategies, regular human advisors may be the cheaper option for you after all.
Scope of service
While being faster and cheaper most of the time, robo-advisory services sometimes lack versatility. It’s one characteristic that humans still excel in.
Your robo-advisor will unquestionably beat the human one at tedious and complex tasks, where automation makes calculations and estimations easier. Additionally, some extra services like tax harvesting and retirement plans are sometimes free of charge as part of the whole package.
But there are some financial and life aspects that your robo-advisor can’t cover for you. And so, the tasks that require unique expertise, psychological and interpersonal skills are still better resolved by humans.
Robo-advisor vs human advisor: shortcomings
As reported by numerous users, robo-advisors lack face-to-face meetings and other types of human interaction. Also, since most of the transfers are automatized, anyone who is a DIY investor type can feel like his role in the process is too passive.
Human advisors lack in the areas of cost-effectiveness, flexibility, and multitasking. Which is all understandable, taking into account that they are not robots.
Robo-advisor vs human advisor: superpowers
The greatest robo-advisor’s superpowers are constant updates, daily tax harvesting, and automated portfolio rebalancing.
The greatest human advisor’s superpowers are physical consultations, emotional support, and other motivational factors that can make a lot of difference.
Bottom Line: Are Robo-advisors Worth It?
Every medal has two sides, and every financial decision has its advantages and shortcomings. It is up to every investor to weigh the pros and cons of each available profit-generating method and to choose according to their needs.
This all leads us to the most important question here:
Should I use a robo-advisor?
If you have an independent, in-favor-of-technology, and risk-evaluating investor mentality, you should use a robo-advisor. Also, if you’re a beginner, this cutting-edge financial platform could teach you a lot at a reasonable cost of service. And, you may be off to a great start.
On the other hand, if you’re used to your human advisor having your back, holding your hand, and pushing you into braver decisions, a robo-advisor may not be what you need. Also, if you’re looking for ways to beat the market and for some more out-of-the-box solutions, paying robo-advising services may just not be worth it.
Robo-advisors are completely legal, customer-friendly, and highly precise investing tools. All this makes them safe to use.
Robo-advisors are not created to beat the market. Instead, they follow the market trends and calculate your best next investment accordingly.
According to the official data from various robo-investor websites, Betterment and Acorns have the best returns so far. Wealthfront and Ellevest follow closely behind.
The biggest concern of most potential investors is — are robo-advisors worth it? The answer to this varies among different investor categories, but in general, robo-advisors are designed to generate profit. So yes, you should be able to make money with the help of a robo-advisor.