Should I Use a Robo Advisor?
Posted on November 21, 2019
Should you use a robo advisor? Whether you are new to investing or not, the automated investing technology that robos provide can alleviate some of the stress and confusion related to investing. If you are not familiar with robo advisors, we suggest reading our breakdown first.
Robo or Human Advisor?
A robo advisor is an ideal tool for those who lack investing experience, want a hands-off investing experience, or do not have the money to work with a full-service advisor. Even seasoned self-directed investors can benefit from the disciplined, automated, and low-cost investment strategies of a robo. The complexity of an investor’s financial situation will also determine his or her fitness for a robo.
Robo advisors enable individuals to access a professionally managed, diversified portfolio with only a small initial investment. Traditional advisors typically require a significant minimum investment that, in the past, could prevent investors from accessing professional help. Working with traditional advisors also tends to be a more involved process. To start investing with a robo, the process is typically as simple as filling out a questionnaire and linking a bank account to fund your account.
What if your financial situation is more complex or you have significant assets? In this case, a robo might not be the most suitable option for you. Robo advisors are a primarily digital experience. Many offer higher-level service tiers with access to live advisors, but the service would not be as robust as that of a full-service financial planner and investment manager who would be able to work more closely with you. Full-service advisors generally allow for more portfolio customization, which can be more important for those with more complex financial pictures. Additionally, as wealth grows so does the benefits of more customized tax, estate, and financial planning.
A Hands-Off Experience
Whether you are a new or an experienced investor, a robo advisor can significantly cut down on the time you dedicate to managing your portfolio. Using an automated algorithmic approach, robo advisors invest in a diversified portfolio, reinvest dividends, rebalance the portfolio, execute tax loss harvesting trades, and more. You can set up recurring deposits to automatically add additional money. For those who enjoy selecting your own investments, a robo advisor can augment your strategy.
What About Performance?
For a variety of reasons—inadequate experience, limited knowledge, behavioral biases, insufficient time to research and track investments, etc—most individuals are statistically poor investors. Most robo portfolios follow a simple investing approach based on modern, best practices for achieving long term results through a well-diversified mix of low-cost, passive index funds. These strategies do not overcomplicate investing and are appropriate for most individual investors.
Numerous studies have shown that do-it-yourself (DIY) investors perform very poorly when compared to standard benchmarks, such as the S&P 500 Index. An ongoing study from Dalbar, a financial research firm, found that, from 1995 to 2015, DIY investors earned 5.19 percent annually on their equity investments, while the S&P returned 9.85 percent, on average. In this study, DIY investors earned almost half of what the S&P did, on average.
The comparative fixed income returns were bleaker. Over the same 20-year period, DIY investors saw an average return of 0.80 percent annually on their fixed-income investments, while the Barclays Aggregate Bond Index returned 6.20 percent annually, on average.
If an investor had invested $100,000 in 1995—60 percent into an S&P Index fund and 40 percent into a Barclays Aggregate Bond Index fund (a common equity-fixed income allocation)—that investor would have ended up with $525,000 in 2015. The average DIY investor would have $211,000 at the end of the period the same period, using the returns from the Dalbar study.
Robo advisors have more nuanced approaches than the above two-fund strategy, but that example helps demonstrate how passive strategies can and have drastically outperformed DIY strategies for individual investors. Using a robo advisor can help introduce a disciplined, simple, and effective approach for an individual investor’s portfolio.
The Next Step
If you feel that a robo advisor is appropriate for your needs, you will have many choices. Below are some of our resources to help you choose the right robo advisor for your needs*:
- How to Choose a Robo Advisor
- Best Robo for First-Time Investors
- Best Robo for Complex Financial Planning
- Best Robo for Digital Financial Planning
- Best Robo from an Incumbent Financial Institution
- Best Overall Robo
- Best Robo for Performance at a Low Cost
We suggest that you use a robo if you:
- are starting to invest with a small amount of money
- lack significant previous investment experience
- want to “set and forget” your portfolio
- want to introduce professional management tactics to your portfolio but keep costs low
*We do not get paid by any robo for any reason. Our selections are based on our unbiased analysis.
Tagged ETF, Financial Planning, Minimum, Performance, Tax Loss Harvesting