From robot vacuum cleaners and smart lightbulbs to cars that help us drive, we’re depending more on machine “intelligence” to conduct our lives.
The trend has hit retirement investing in the form of “robo-adviser” companies that offer automated investment advice and management for much smaller fees than human advisers charge.
So far, robo-advisers aren’t common within workplace retirement plans, and they’re used to manage only “a tiny fraction” of investments, according to US News. But some analysts believe they could represent the future of investing.
You probably know the names of some frontrunners, including WealthFront, Betterment (affiliated with Fidelity Investments), LearnVest, Vanguard Personal Advisor Services and Schwab’s Intelligent Portfolios. Investopedia lists nearly two dozen of these companies.
Cutting out human advisers
Robo-advisers are pitched as a way to cut out financial advisers — and the fees they charge. The way it typically works, clients use online tools that allocate funds into a diversified portfolio of investments, often at rock-bottom cost.
The asset mix is typically decided by how the client answers an online questionnaire that asks about such things as your risk tolerance, retirement timeline and how much is being invested. Portfolios are usually held in shares of lower-cost exchange-traded funds (ETFs).
Using computer algorithms to design portfolios is nothing new. “Robo-advisers use the same software as traditional advisers,” says CNBC. But robo-advisers cut costs by stripping out estate-planning, retirement-income planning, tax strategies and other services traditionally performed by financial planners.
Robo-advisers are often described as a product designed for millennial investors, given their comfort with computers. But the simplicity and cost-effectiveness of robo-advisers has potential appeal for all ages.
There are trade-offs, however. These pros and cons can help you decide if robo-advice is right for you:
Pro #1: Lower fees
Robos drive management fees down to levels ranging from zero to 0.75 percent of your account balance. Fees may also vary depending on the amount you have invested. You may also have to pay management fees charged by the funds you’re invested in. This LifeHacker chart compares fees and minimum investments for six robo-advisers.
Fees matter more than you might imagine. A total charge of 1 percent of your investments is standard, says business writer Sarah O’Brien at CNBC.
The cost over time for managing your 401(k) can be significant.
“What’s 1 or 2 percent? Well, over your working life it could be enough to buy a house,” says Money Talks News founder Stacy Johnson. As far as he’s concerned, paying anything is paying too much. Check out A Simple Way to Invest Your Retirement Savings for his no-cost, 15-minute approach.
Pro #2: Less drama
Humans are fallible. Even the smartest and best-trained investors, professionals and amateurs, can let pride, optimism and stubbornness undermine results. With software, you get steady progress along a course you have set without human responses to market highs and lows.
Pro #3: Low minimum investment
Another attraction of robo funds is the relatively small amount required to get started. With $5,000 you can open a Schwab Intelligent Portfolios account, for example. Vanguard Personal Advisor Services, which offers some personal advice, requires $50,000 to sign up. Financial planners, in contrast, often require minimum investments of $250,000, $500,000 and up.
Pro #4: Tax strategies
Robo-advisers can include services that help lower your taxable income. Most robos “use the tax-efficient stock index funds in the taxable accounts, and for your tax-deferred accounts they use funds that are taxed at the highest rates, such as bond funds and REITs,” writes financial planner Allan Roth at AARP.
If you’re taking this route, look for a company that offers tax-loss harvesting, a complex service that can save you money by selling money-losing securities to offset gains from others.
Pro #5: Portfolio rebalancing
Portfolios grow out of alignment with your asset allocation over time. They should be periodically rebalanced by selling and repurchasing investments to restore the original asset allocation. Some robo-advisers put this job on autopilot for clients.
Con #1: No (or less) hand-holding
The robo-adviser concept in its purest form eliminates human advisers to cut costs. Some robo-advisers now are “improving their automated services or providing on-staff experts” says O’Brien at CNBC. She reviews adviser options available from WealthFront, FutureAdvisor, Betterment, Vanguard and Schwab.
Adding humans to robo-advisers may not matter much to clients though. Since the scope of their advice is confined to the funds placed at that company, it may also be a good idea to talk with a fee-only certified financial planner occasionally:
- to take all your finances into account, especially if you also have a workplace retirement plan and other investments.
- to review your robo-adviser’s portfolio and allocations in case adjustments are needed.
- to advise you on complex situations involving taxes, an inheritance, college savings or retirement income planning, for a few examples.
Learn more about picking an fee-only adviser: How to Choose the Right Financial Adviser.
Con #2: Investment bias
Given the same assignment, different robo-advisers are likely to produce different asset allocations and portfolios, as The Wall Street Journal learned. That’s because each company has a somewhat different model, uses different software, emphasizes different investment styles and purchases from its preferred list of ETFs. As the Journal explains:
[T]here are differences among online advisers, and the same investor can get vastly different recommendations depending on the adviser. That puts the onus on investors to find the right match for them.
For instance, the Journal says Wealthfront makes 5 to 28 percent of its portfolio purchases in emerging-market stocks. These “tend to be more volatile,” the Journal says, and that could expose your investments to more ups and down than you hoped.
Con #3: Garbage in, garbage out
Your robo-adviser’s guidance depends on the subtlety of its intake form and on the information it gets from you. “The answers you give to a tool’s initial questions about your situation and risk tolerance can greatly affect the investment recommendations and might lump you into an investment path that isn’t truly reflective of all your goals,” writes The Chicago Tribune.
There’s no one-size-fits-all answer here. You can always explore further by making a small investment and seeing how well a robo-adviser meets your needs. For plenty of investors, the benefits outweigh the cons, but so much depends on your needs. In general, The New York Times concludes:
They may be suitable accumulation tools, but if you need to carefully plan retirement, there are better-suited online sites. Or, you may just need an experienced adviser or firm.
What’s your take? Would you trust a robo-adviser with your retirement fund decisions? Share your thoughts in comments below or on our Facebook page.