Automate your investing with robo advisors.
Robo advisors have become a popular option for American investors who prefer an actively managed account without the expensive fees associated with hiring a human manager. Robo advisors are digital account management services that utilize trading algorithms rather than human input to actively buy and sell stocks and other assets. For investors lacking an advanced understanding of how the market works, robo advisors make normally difficult investing decisions automatically based on changes in market conditions. The software also provides helpful account maintenance procedures such as automatically reinvesting dividends and re-balancing portfolios. Here are nine things investors should know about robo advisors.
Robo advisors are cheap.
Robo-advisor services are much lower-cost than their human counterparts. For example, leading robo-advisor service Wealthfront offers its services free of charge for clients’ first $10,000 in assets and then charges only 0.25 percent in fees above that threshold. By comparison, traditional advisory services from Buckingham Asset Management cost clients up to 1.25 percent in fees annually. Robo-advising services are certainly low in cost, but investors need to understand there may not be a human being monitoring and protecting their portfolio. In addition, while algorithms sound impressive, they are only as good as the experts that design them.
Robo advisors can help minimize tax losses.
Taxes can take a major bite out of investment returns, especially in actively-managed portfolios. Robo-advisor services like Wealthfront advertise tax-loss harvesting, a trading strategy that involves selling losing stocks and replacing them with similar stocks in the portfolio. This strategy allows investors to benefit from writing off investing losses while remaining fully invested in the same long-term strategy. Active managers have been taking advantage of tax-loss harvesting for decades, but the process is now fully automated and available to retail investors for a fraction of the cost a human manager would charge.
Robo advisors have limited flexibility.
While leading robo advisors have customers answer questions to choose the best type of investing strategy for each individual, they can only go so far in customizing their algorithms. Clients can set and even edit preferences, time horizons, goals and other variables. However, financial planning can be so overwhelming and complex that some clients may benefit more from regular discussions with a human advisor. Human advisors can also help clients deal with the emotional challenges of investing, such as riding out short-term market volatility. Robo advisors don’t necessarily have the human touch when it comes to reassuring customers.
Investors are skeptical of robo advisors.
Despite a meteoric rise in popularity, a recent survey by LendEDU found that a large number of millennial investors don’t fully understand how robo advisors work and are skeptical of their performance. Only about 25 percent of the 500 investors polled reported using a robo-advisor service. Among those that were not robo-advisor customers, 62 percent of respondents said they didn’t even know what a robo advisor was. Two-thirds of millennials believe a robo advisor is more likely to lose their money than a human advisor. Roughly 70 percent felt a human advisor would deliver a better return than a robo advisor.
Results may vary.
A study by Condor Capital Management found that investment returns from robo advisors can vary significantly. In 2016, Condor tested the performance of nine top robo-advisor services by opening up accounts at each company. The firm customized preferences based on a hypothetical investor in a high tax bracket with moderate risk tolerance who is anticipating retirement in 20 to 30 years. Full-year performance ranged from a 10.7 percent gain for Schwab to a 5.5 percent gain for Vanguard. For comparison, the Standard & Poor’s 500 index delivered nearly 12 percent total return on the year.
Robo advisors haven’t been truly tested.
The algorithms driving robo advisors have strong track records delivering consistent annual returns. However, it’s important to remember that leading robo-advisor services are so new that their track records don’t include the financial crisis of 2008 or other recessions. Sure, these services have performed well for the past eight years or so, but the stock market is up nearly 150 percent in that time. Even a portfolio of stocks selected at random would likely have performed relatively well during that stretch. The first true test of the viability of robo advisors may not come until the next U.S. recession hits.
Robo advisors are easily accessible.
Most human fund managers require clients to have at least $100,000 in assets. However, investors can typically qualify for robo-advising services with $5,000 or less. Betterment, one of the most popular robo-advisor services, has no account minimums. Wealthfront even encourages smaller investors by managing clients’ first $10,000 free of charge. Historically, investors with modest savings had limited options when it came to money management. Today, robo advisors are available to anyone with an internet connection. As more services pop up, investors can expect competition to drive promotional deals as well, making it even more appealing to open an account.
Algorithms are based on Nobel Prize-winning theories.
Each robo advisor has unique trading algorithms that deliver varying results, as the Condor study proved. However, most of the algorithms are derived from generally accepted investment theories focused on minimizing risk and maximizing return. When Eugene Fama and Robert Shiller won the Nobel Prize for economics in 2013, robo-advisor Betterment revealed that its algorithm “relies on many of their insights.” Betterment and Wealthfront disclose that they use the same principles of modern portfolio theory that earned economist Harry Markowitz the Nobel Prize in 1990. Robo advisors may be computer programs, but their strategies are based on sound human logic.
Robo advisors manage $224 billion and counting.
Global robo advisors already account for more than $224 billion in total assets under management, according to a 2017 report by Statista. That number is expected to grow by 47.5 percent annually and exceed $1 trillion by 2021. Statista estimates that nearly 100 million people will use robo-advising services within the next four years. With more than $47 billion in assets under management, Vanguard is by far the largest robo advisor in the world, followed by Schwab Intelligent Portfolios ($10.2 billion), Betterment ($7.3 billion) and Wealthfront ($5 billion). According to B.I. Intelligence, the U.S. alone has more than 200 different robo advisors.
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9 Things to Know About Robo Advisors originally appeared on usnews.com
