There used to be only two ways to manage money. You could either make your own decisions and do it yourself, or you could place your money with an investment company and pay for human advice. Today, thanks to technology, there’s a third way: robo-advisers.
A robo-adviser also entails turning your savings over to an investment firm, but the advice and management you receive comes from a computer rather than a person. You supply your details online, transfer your savings to the company, and a computer algorithm dictates how your money is invested.
Investing based on computerized advice may seem strictly 21st century, but it’s actually old school. While working as an investment adviser in the 1980s, my firm, EF Hutton, offered a computer-generated asset allocation model for around $100. The execution of the resulting trades, however, was a job only a human could perform. Today’s robo-advisers do it all. You can invest your life savings without ever interacting with a human counselor.
Some investment houses offer both traditional advice and the computerized kind, so if you do want to talk to a human expert, you can. Others firms offer only the automated version.
Ready to let a robot take over your portfolio? Here are some things to understand and questions to ask as you explore various options.
What do they invest in?
While human investment advisers might suggest individual stocks and bonds, most (but not all) companies providing robo-advice offer only mutual funds and ETFs (Exchange Traded Funds). This is good. ETFs are the lowest-cost way to own investments, as well as the best way to diversify. Learn more about them in articles like this one.
How much does it cost?
Humans charge for their advisory services in a variety of ways. They can bill by the hour, earn commissions on each trade, or charge an overall fee based on assets under management, either quarterly or annually. This fee, known as a “wrap” fee, is typically about 1 percent.
Robo-advisers also charge a wrap fee, but at a much lower rate, typically ranging from 0.15 percent to 0.5 percent annually. As with human advisers, these fees are in addition to any internal fees charged by investments like mutual funds.
What exactly do they do?
Sign up with either a human or robo-adviser, and you’ll answer questions about such things as the amount you’re investing, your income, age, goals and tolerance for risk. Those factors are what any adviser — human or computer — uses to select the proper investment mix.
For example, if you’re young with a healthy appetite for risk, your robo-adviser might suggest a portfolio of ETFs that include big company stocks, small company stocks and international stocks. If you’re older and/or more conservative, you’ll end up in more bond and dividend-paying stock ETFs.
Once your portfolio is in place, your robo-adviser will keep it balanced. In other words, should a rising market lead to an increasing percentage of your savings in stocks, the computer will automatically sell some of your stock investments and redistribute the money into other investments to maintain the proper mix.
Many robo-advisers also provide what’s known as “tax-loss harvesting,” which is a fancy way of saying they’ll automatically sell losing investments to offset future gains or create tax deductions.
What about my 401(k) or IRA?
All robo-advisers will manage a taxable account or your IRA. Some will also manage other types of accounts, like a 401(k).
Check out “13 Dumb Investing Moves and How to Avoid Them.”
Where’s my money?
When you invest with a robo-adviser, you’ll typically be sending your savings to the investment company. There are situations, however, where you’ll transfer your money to a third-party custodian, like to a big brokerage firm, and the robo-adviser manages it there.
What choices are there?
As robo-advisers have gained in popularity, there are dozens of options. Here’s the skinny on a few of the most popular. In addition to money management services, most also offer free finance tools, so it wouldn’t hurt to visit each site and poke around a bit. They’re all user-friendly.
Betterment: Investing in: Stock and bond ETFs. Cost: From 0.15 percent (for accounts of $100,000 or more) to 0.35 percent. Minimum: None.
Wealthfront: Investing in: Stock and bond ETFs. Cost: $0 for amounts up to $10,000, 0.25 percent on amount exceeding $10,000. Minimum: $500.
Wisebanyan: Investing in: Stock and bond ETFs. Cost: $0 Minimum: $0. (Company intends to make money by selling add-on services.)
FutureAdvisor: Investing in: Stocks, and stock and bond ETFs. Cost: $0 for guidance on existing portfolios, 0.5 percent for managed account. Minimum: $10,000 (for managed account).
Personal Capital: Investing in: Stocks, and stock and bond ETFs. Cost: 0.49-0.89 percent. Minimum: $25,000.
Should you use one?
In a book I wrote many years ago called “Money Made Simple,” I suggested a simple way to figure out how to divvy up your long-term savings. Here’s the formula:
- Step One. Subtract your age from 100 and put the resulting percentage into stocks.
- Step Two. Divide what’s left equally between bonds and cash.
So if you’re 20, you’d have 80 percent in stocks, and 10 percent each in cash and bonds. If you’re 80, you’d have 20 percent in stocks, and 40 percent each in cash and bonds.
In the book, I compared this basic technique with an asset-allocation calculator from a well-known financial website. Here’s what that calculator required as inputs:
- How much money you have now in various types of investments.
- Your tax bracket.
- How much of your savings you intend to spend within two years.
- How much you intend to spend within 10 years.
- How much you intend to leave to your heirs.
- Years to retirement.
- How much of your savings is in tax-deferred accounts.
- How much equity you have in your home.
- How many dependents you have.
- Your volatility tolerance.
- Your economic outlook.
- Your inflation forecast.
So how did the results of this super-sophisticated calculator differ from those of my ridiculously simple method? To find out, I input information for a 35-year-old and tried to pick middle-of-the-road answers for the calculator. The results:
- My take-your-age-from-100 method: Stocks, 65 percent; bonds, 17.5 percent; cash, 17.5 percent.
- Wizard-of-Oz calculator: Stocks, 64 percent; bonds, 18 percent; cash, 18 percent.
Why would someone make a calculator so complex when something you can do in your head does the same thing? Because they want you to think they’re smart and you’re not.
The point of all this is that I don’t think it’s necessary to pay for financial advice, whether human or robot.
That being said, robo-advisers don’t charge much, offer some cool features, have low minimums and may be just the ticket to get you started. So if you want to use one, I wouldn’t try to talk you out of it. Hit the links above to learn more and compare services.
Have you had any experience dealing with robo-advisers? Share your opinions below or on our Facebook page.
Disclosure: Some of the links in this article may be affiliate links, meaning we’ll make a buck or two should you sign up for the service. This costs you nothing, doesn’t influence our opinion and helps us keep the lights on. Thanks!