Controversy has surrounded robo advisors since they first became prominent on the financial scene back in 2012. Robo advisors are defined as independent financial wealth management firms who exist solely online and utilize computerized algorithms to provide financial advice to clients.
Perhaps the biggest controversy that robo advisors have faced is the doubt over whether algorithm trading can really provide solid financial advice without any human judgement involved.
Despite this concern, many people consider algorithm trading to be the best way to invest. In fact, according to a study done by Corporate InSight, the robo advisor industry held $21 billion in assets as of July 2015.
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Recent Investment News
Robo investing is under more scrutiny than ever since the Massachusetts Securities Division announced that it didn’t believe robo advisors were capable of living up to their state standards for investment advisors. This means that robo advisors may not be able to register as financial advisors in the state of Massachusetts. This is a major blow to the algorithm trading industry and could become a big problem if other states begin to follow suit.
On the hand, the Department of Labor has recently released a new fiduciary rule which states that brokers who provide retirement investment strategies to their clients must begin putting the clients’ best interests above all else. This ruling was put into place to protect clients who were, in lieu of managing risk, being given poor advice or charged hidden fees because it was in the best interest of the broker.
In reaction to the new rule, some firms have threatened to drop their lower-net-worth investors – which could lead to a surge in the use of robo advisors.
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Are Robo Advisors Worth It?
While there are many different investment solutions available to consumers, robo advisors are considered by many to be the most investor-friendly and cost-effective option. That being said, deciding to utilize a robo advisor does come with its own set of concerns.
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The robo advisor has a limited scope of investors’ finances.
Robo advisors provide financial advice based on the client’s answers to a few questions, which cannot provide a full scope of a person’s full financial situation.
For this reason, some of the types of investment advised by the algorithm trading software may not actually be right for the client in the long run.
This concern will most likely be resolved as advances in technology lead to more integrated software that can access a person’s full financial history and provide a bigger picture.
There is no brick-and-mortar office to visit for a face-to-face meeting.
Fluctuations in the market are par for the course, but many investors will panic at the first sign of a bad market day and want to sell their shares.
A human financial advisor can talk those investors down, provide them advice on managing risk as well as future investment strategies, and offer reassurance that they will be glad they hung in there when the market picks up again.
Not having a brick-and-mortar office building that clients can run to and have a financial advisor assuage their fears is often touted as one of the biggest cons of robo advisors.
However, this issue is already beginning to be resolved through the rise of hybrid financial management firms which pair a human financial advisor with automated algorithm trading software. The number of firms offering these types of hybrid services will most likely grow as time goes on.
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Robo advisors offer limited types of investment.
Most robo advisors offer a much more limited selection of investment opportunities than their brick-and-mortar counterparts.
An established firm of human financial advisors can provide clients with a myriad of different ways to invest that are right for growth in the different aspects of their financial lives – such as real estate, funding children’s college funds, and estate planning. Over time, as the robo advisor industry continues to grow and develop, some investment solutions to this limitation may be presented.
There are also many things that robo advisors get right, which is why so many people consider them to be the best way to invest. Below are things to consider when asking yourself whether robo advisors are worth it.
Robo advisors do provide high-quality investment advice.
While their investment options may not be as widespread as some of their brick-and-mortar counterparts, the investment advice that robo advisors provide is usually solid.
The algorithm trading software used by robo advisors is based on Nobel Prize-winning theories and works well.
Through the rise of robo advisors, many people are able to receive sound investment advice that can help them grow their portfolio and save for their future.
Robo advisors make receiving financial advice affordable for everyone.
Through low-cost management fees and little to no minimum required to begin investing, robo advisors make it possible for people – who otherwise would not be able to do so – to seek financial advice for investment solutions.
Before robo advisors, only those with a large amount to invest were able to seek the advice of established financial advisors. However, robo advisors have opened this door up to everyone.
Robo advisors can configure data in a way that humans cannot.
Even the greatest financial advisor on earth cannot truly compete with a computer’s ability to sort through large amounts of data, calculate risks, and determine all possible variables.
The algorithm trading software can do the job of managing risk and presenting different ways to invest without any emotion or concern for its commission or own gain in a way that a human financial advisor simply cannot, no matter how impartial he/she tries to be.
When asking the question, “Are robo advisors worth it?” it’s important to understand the types of investment strategies that they use.
With robo advisors, users answer a series of questions, and those answers are then evaluated by the algorithm trading software to determine investment strategies that take into account managing risk and the best way to invest for the time period given.
The user is then presented with a few different prepackaged investment portfolio recommendations to choose from.
Most robo advisors utilize passive investment solutions, sometimes known as a buy and hold strategy. This strategy works best for investors who have a long period of time to grow their investment and are not seeking quick returns.
This is one of the reasons why robo advisors are so attractive to young investors. If you are getting closer to retirement age and are looking to boost your portfolio in your last few years before retirement, then an algorithm trading firm may not be the right choice for you.
Most of the offered robo advisor portfolio offerings are made up of index funds and exchange-traded funds (EFTs).
These portfolios are a good fit for many young investors because they generally carry low expense ratios and grow over the long term. These low expense ratios allow robo advisors to keep their costs low – a major draw for clients.
Benefits Offered by Robo Advisors
In addition to their low-cost wealth management services, many robo advisors offer free tools to their clients, including the ability to analyze accounts held with other investment companies.
On most robo advisors’ websites, clients can take advantage of a wide assortment of tools and resources related to financial planning and saving for life events, such as a wedding, baby or starting a college savings plan.
Many also offer video resources explaining investment strategies and the importance of managing risks in a way that is easy to understand. People who are new to financial planning may find these tools and resources to be very valuable.
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One strong consideration when asking yourself the question, “Are robo advisors worth it?” is the low cost to invest. Due to not having the high overhead of leasing a big office or a team of high paid professionals on their payroll, robo advisors are able to keep their costs to a minimal. These savings are passed on to clients through their low management fees.
Robo advisors tend to cost only a fraction of what management services through a mainstream financial advisement firm would cost.
Their management fees run much lower than typical financial firm fees, and they do not tend to charge an annual fee whereas many brick-and-mortar financial firms do. Many financial advisors also work on a commission base while robo advisors do not take a commission.
The low cost is a major reason that many people consider robo advisors to be the best way to invest, at least when they are first getting started.
The Future of Robo Advisors
While it is impossible to truly predict the future, it doesn’t appear that robo advisors are going to be going away any time soon.
Their low-cost fee structures and easy-to-use platform make them a draw for young investors, and financial firms are taking notice.
In order to compete and attract new clients, some financial firms – such as Vanguard – have begun integrating algorithm trading technology with their existing financial advisors in order to offer clients the best of both worlds at a much more conscientious cost.
While they do offer a low-cost platform for new or young investors, investments made with robo advisors are rather limited.
For this reason, it may be a good idea to start out with a robo advisor and later, once your portfolio has grown to a significant amount, switch your account to a human financial advisory firm that can provide more guidance and long-term payoff.
Mainstream advisory firms can also provide more specific planning and suggest different ways to invest to help you meet both your short-term and long-term goals. Robo advisors are just not set up to be able to do this, which makes them great for a short-term strategy when you are first starting out.
As algorithm trading continues to develop and move into the mainstream, we are sure to see changes in the financial advisory industry as a whole. Being forced to compete with robo advisors for more cost-conscious and technology-focused clients is leading mainstream financial firms to take a serious look at the advantages of using algorithm trading as part of the investment strategies they present to clients. This allows them to lower costs while still offering the advantage of having someone available to answer questions and give event-specific advice.
The Bottom Line
Robo advisors offer an easy-to-use, low-cost platform that is perfect for new or young investors looking to get started. They utilize passive investment strategies that work better for the long-term investor.
Clients who want help reaching short-term goals or planning for life-specific events are probably better off seeking advice from a human financial advisor, but an individual who is looking to begin building wealth with a small initial investment will find the algorithm trading platform to be a good fit.
Robo advisors can be a great place for investors to start, but it is important to keep their limitations in mind over the long run.
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