Robo-advisors are currently the hot thing in investing. Everyone cannot stop talking about the ability to use one a computer program for cheap to help them invest. You know what though? I see robo-advisors as mostly useless.
Financial Advisors have their Place
Let me first reiterate, I get why someone would want a financial advisor. Financial advisors are not for me given I have learned how to manage my own financial situation. However, I understand not everyone has the mindset to do so. To some the concept of managing their finances is too daunting. Others would prefer to spend their time doing something else. I respect that as well. Even though I spend hours each week writing about personal finance because I enjoy it deeply, I also understand that some people hate to think about money. Those are the people who should be using a financial advisor.
What do you get for your advisor?
What is a financial advisor really offering? If you get a good one and you properly vet them they are offering a holistic plan. This plan starts with what you value and want out of life. They work from there to encompass how to achieve those things. It captures the personal of the personal finance equation. Without that personal aspect, it is largely useless as your financial life should mirror what you personally value. It will do you no good to dump every dime into long term illiquid investments if you plan to buy a house next week.
Conversely why would you keep everything in cash if you do not need the money until retirement. This is a simplistic example, but the personal in personal finance is infinitely complex. So, the first ding against robo-advisors is they cannot support infinitely complex. Sure, they can support some variations to support categories of people, but by their very nature they won’t capture all aspects of your personal situation.
The Limited Scope of Robo-Advisors
My concern/issues with robo-advisors does not end with the personal part of finance. The second issue I have with them is that they only cover one aspect of your plan. They take the thought out of investing. On the face of it that’s great and all, but what does this really accomplishing?
Goals, Spending, Earnings are not Managed by Robo-advisors
First your investment plan should be but one part of your overall plan. These robo-advisors completely ignore those other aspects of your life. Whether you invest in index funds and how frequently is important, but I would argue understanding how to get to your financial goals, control your spending, and increase your earnings are just as important. They are also interdependent, and yet robo-advisors ignore these areas of your life.
Investing for the Long Term is Easy
Second, the part that robo-advisors cover is the easiest part of your plan. Yes, you heard me right. Investing for the long term is easy. Really for most people their retirement accounts need only consider 3-5 investment choices. Those 3-5 investment choices would all be low cost index funds, split between your domestic market large cap, international markets, bonds, small caps, and potentially real estate. That’s really all, at least generically, anyone should need to retire. It’s all those robo-advisors are really doing.
Asset Allocation is the Hardest <sic> Part of Long term Investing
Sure, within those 3-5 there is also the decision on how much of each to buy. The thing is there is even a solution there. The first is just copy what the robo-advisor suggests. They are well publicized so it’s not that hard. Or you could ask someone. Once you set it you largely can forget it until retirement so it’s not that hard.
Still perplexed? There is a category of funds called target date funds that will adjust the percentages for you. Pick up one of these funds and call it a day. Several of the ones from large companies like Vanguard cost a lot less than a Robo-advisor as well. After all, you are paying the robo-advisor for the tool plus the cost of the underlying funds. That extra drag on your funds adds up over time. Even an extra say .3% for a robo-advisor over 10 years on a million dollar portfolio would cost you almost $40K. Why spend $40K on essentially something you can do yourself in a few minutes.
Automatic Investing can be done without a Robo-advisor
The only other value besides choosing your stock allocation and underlying funds that a Robo-advisor brings is the ability to invest automatically. I have news for you. You can do this for free with options like your 401K, automatic withdrawals from your savings account to a brokerage, or any number of other options. Again, you are paying for something you could solve in a few minutes, set once, and never look at again. Anything but free here would be a colossal waste of money.
Ultimately if someone invented a robo-advisor that could weigh in on your entire life picture and give you advice on how to correct your situation holistically I would be in favor of them for certain types of people. As it is, I just see them as too simplistic to help those who need help and non value adding for those who already understand finance.
What is your take on robo-advisors? Do you use one? If so why?
Investing and personal finance is one of the rare areas where a layperson can be as competent (and perhaps more so) than a pro.
I think we all owe ourselves to understand at least the basics, and from there we can hire a real live person to shore up any areas outside of our expertise or do a financial tune-up when our situation changes.
I do worry that robo-advisors could leave folks missing the forest for the trees as you note above, and leave one feeling that you’ve successfully outsourced something when you really haven’t.
I’d never use one myself, and I’ll do my best to convince others that they’re not the best solution.
That sums it up really well. Not only is there an added cost to these Robo-Advisors. Putting too much stock on them risks wrecking the rest of your finances if you lose sight of how small an area they really cover.
I don’t use a robo-advisor as I am a bit of an active investor and tends to invest in different classes. On top of equity investment, i also invest in real estate and write options contracts myself. A robo-advisor will not be able to do that for me. If people really want to minimize their fees, just pay to an advisor’s time to set things up. Once their passive portfolio is setup, they can pay to have the advisor review it once every couple of years. This is a much cheaper passive investing option.
Great approach Leo. A real financial advisor can help you get things started, but at some point the training wheels can easily come off saving you bunches of money.
I use Betterment for two reasons: Tax Loss Harvesting & fractional shares. You can do TLH yourself but Betterment is monitoring your account continuously for opportunities. I used to do TLH myself but it was limited to the market prices in late November/early December. In theory, Betterment should be able to harvest more losses than I could.
Betterment allows for fractional purchase of ETF shares. Not all brokerages allows for that. Vanguard does not.
Is this worth the 0.35% cost? I’m not sure. I felt semi-comfortable at 0.25% but at the higher cost it has given me pause.
For what it is worth, after I retire and start pulling money out of my accounts, I plan on moving the Betterment accounts to Vanguard because of reduced opportunities to TLH and/or buy fractional shares making Betterment less attractive.
A “real financial planner” usually costs more and frequently have conflicts of interest although the aborted Fiduciary Rule has made the industry more transparent I read. The added costs and lower performance of their commissioned investments negate the value of using many financial advisors; not all but many if not the majority.
You definitely have to be careful with Financial Planners. But, I can acknowledge that there are some people that just cannot manage their own finances even if only initially. But Advisors don’t help for that.
TLH is about the only argument I’ve heard in favor of the advisors to date. The question is have you beat your previous process by .25 or .35%?
I definitely beat the previous portfolio by over 0.35% but the rise of the robo-advisor coincided with my disenchantment with mutual funds. I dumped several mutual funds with expenses around 1% to go into index tracking ETFs at Betterment.
For Dollar Cost Averaging, robo-advisors can be cheaper than self-built ETF portfolios because of the trade commissions. If you are the type that wants to contribute $250 per week, the commissions at many brokerages will run $20 to $25 per month for weekly DCA. Many brokerages do not have dividend reinvestment either.
TLH was the big one (although I’ve cooled towards it) but fractional shares and unlimited buy/sells are features I take advantage of most.
In my experience most brokerage houses waive their trading commissions if you buy their ETFs. Schwab does for example and has excellent Index funds. I’m not buying it.
I’ve never quite understood the attraction of robo-advisors either. As you mention, investing for the long term is pretty easy. The time someone would spend learning about robo-advisors, they could learn about the ease and success rates of passive index funds.
As Dan mentions in the post above, the other added value touted by robo-advisors is tax loss harvesting. I don’t think I would get enough value out of that service to justify the costs.
I’ve read a few analysis on the manner that state the costs are not outrun by TLH. https://finance.yahoo.com/news/inside-robo-advisor-tax-loss-040000033.html
Exactly what I was thinking about these services.
There is a special target audience for these cyber advisors, but the investment part can be done by anyone with a little bit of time and effort spent on the topic.
Tax might be a point where they might be helpful, but concentrating on better returns will lead to comparable results..
Another point to consider is flexibiity.
It´s all about financial independence, so we should be independent on static plans and fixed arrangements, set up by other people or machines.
Do it yourself.
Flexibility is definitely the name of the game.