What Is a Robo Advisor and When to Use One

Americans are investing in greater numbers than ever before.

In 2020 alone, investors opened more than 10 million new brokerage accounts, according to JMP Securities.

Many of these investors are turning to automated investing with robo advisors, which saw a surge in new account openings in the early months of the pandemic.

New account openings at TD Ameritrade’s automated investment platform rose 150% during the pandemic compared to the same period the year before, according to Bloomberg. Meanwhile, Charles Schwab reported March 2020 was one of its best months for account growth.

At the same time, the volatile market drove many investors to seek guidance. According to a recent study from Nationwide, the pandemic drove 1 in 4 respondents to seek out a financial advisor for the first time.

“One of the biggest impacts of the pandemic was its shock to the economy and markets, and it’s clear that people sought third-party advice to weather the storm,” says Donna Bristow, chief product officer of wealth at Broadridge Financial Solutions.

So what’s better: a robo advisor or a human financial advisor? The answer lies in the situation. Certain investors may be better served by a robo advisor, while others could benefit from the personal touch of a human financial advisor. Here is how to decide whether a robo advisor is right for you.

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What Is a Robo Advisor?

A robo advisor is a digital platform that provides automated investing services. These platforms are usually algorithm-driven. While some provide human guidance as a supplementary service, the objective is to take the human emotion out of investing decisions. They take a numbers-driven approach to create an investment strategy by looking at an investor’s risk tolerance and financial goals.

“Investors like robos for their low fees, digital-first nature and user-friendliness,” Bristow says. “Robos are also fairly reliable and produce favorable outcomes during bull markets, so investors are able to take advantage of market upswings.”

[READ: Should You Get a Financial Advisor’s Advice Before Investing in Bitcoin?]

When Should You Use a Robo Advisor?

“A robo advisor would be a logical investment tool for someone who is testing the waters with investing and is not ready to commit to a full-time financial advisor,” Bristow says. “It’s a no-frills way of investing and doesn’t require monthly or quarterly portfolio human reviews, leaving the investor to chart their own course, leveraging technology.”

Often younger investors like to get their feet wet with a robo advisor, says Ryan Shuchman, investment advisor and partner at Cornerstone Financial Services. “These investors generally have a higher risk tolerance primarily given their extended time to retirement, so a robo advisor can help with simple, equity-centric allocations.”

Robo advisors have also helped democratize investing by making it more accessible to the masses. With advisory fees often around 0.25% to 0.35% per year and accounts that can be opened entirely online by answering a few simple questions, robo advisors can ease the process.

And now, even the 401(k) market may be primed for robo advice.

“Workplace retirement plans are a market with many participants who have limited access to personal advice,” says Harshendu Bindal, managing director of digital strategy and wealth management for Franklin Templeton. In such markets, robo advisors can be an effective means of getting investment help to a large number of people.

Retirement service provider Empower’s recent acquisition of Personal Capital suggests there may be more retirement plan and robo advice collaboration in the future.

When Should You Use a Human Financial Advisor?

Robo advisors have a lot going for them, including low costs, ease of use and automation. But human financial advisors have their own strengths.

“A human advisor provides the benefit of being able to actively manage emotions, your portfolio and adjust accordingly to your needs,” Bristow says. “Finances are deeply personal and individualized, and an advisor can tailor your portfolio to meet your exact needs.”

Volatile markets, like the ones caused by the COVID-19 pandemic, are a prime example of when a human advisor can add value. “By working with a human advisor, investors can have an open and honest conversation about how their financial situation might have changed due to the pandemic and adjust course quickly if necessary,” Bristow says. “Human advisors provide the benefit of being nimble and providing context to the upswings and downswings in the market.”

Your robo advisor isn’t likely to be a source of emotional reassurance during volatile markets, which is one reason investors with a lower risk tolerance may be better off working with a financial advisor. Conservative investors may also benefit from a financial advisor who can take their risk tolerance with a grain of salt.

Left to a robo advisor, risk-averse investors may end up with overly conservative portfolios, Shuchman says. “A human advisor can help guide the pros and cons to risk in the portfolio.”

Likewise, investors within five years of retirement or in retirement should seriously consider a human financial advisor, he says. “These time periods are the most crucial to get right, and a robo advisor may lack the ability to successfully navigate the human and financial factors at play.”

High-net-worth investors with sophisticated tax and legacy planning considerations can also benefit from a human financial advisor, he adds.

[READ: Q&A: Schroders’ Head of Sustainability Talks ESG Investing.]

Financial Advisors Using Robo Advisors: The Best of Both Worlds?

When choosing between a robo advisor and human financial advisor, it isn’t necessarily a question of one or the other. Financial advisors can use robo advisors to enhance their practice.

“Instead of viewing the technology as disruptive, advisors can lean into the technology and make it more powerful with human touch,” Bristow says. “An advisor can use a robo to drive efficiency, improve decision-making and use the extra time to foster a deeper relationship with clients.”

This is something Bindal is seeing in the dense realm of retirement plans, where the ratio of financial professional to investor skews heavily toward the investor. “Many financial professionals who specialize in serving the retirement plan market do their best to provide high-quality education and guidance to individual participants within these plans,” he says. But the problem is there are far more participants than available advisors.

“When a financial professional incorporates a robo advisor into their practice, they have the opportunity to deliver personalization at scale,” Bindal says. “So the financial professional is solving for goals-based personalization, access and quality, with the inclusion of a robo advisor.”

By working together, robo advisors and financial advisors can each focus on what they do best. But “if a human advisor is using a robo advisor for the allocation, and providing little additional guidance and support, then the client may question the value of the fees,” Shuchman says.

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What Is a Robo Advisor and When to Use One originally appeared on usnews.com

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