5 Questions to Ask Before Choosing a Robo Advisor | Guide and Review
New robo advisor investment advisory algorithms are being launched all the time. We’ll show you how to pick the one that’s right for you.
This trend is one of the hottest in investing circles today, and it comes complete with a science fiction-inspired name: robo advisors. If you had told people fifty years ago that they would trust a machine with the investment of thousands of their dollars and their entire financial future, they would have locked you up.
So then, the question arises: Can machines give you good advice about how to invest your money? As we will see, your answer to that largely depends upon your answers to some key financial questions about your style of investing and your comfort with a few different aspects of investing.
These are the main questions you should address when deciding whether to go with robo advisors:
- Do you trust algorithms?
- Are you a hands-on or hands-off investor?
- How risky are you?
- Do you already have money invested with a financial services firm and want to keep it there?
- Is a sleek user interface or mobile app important to you?
We’ll provide some advice about how to think about these issues in connection with your robo advisor comparison.
Let’s get into it.
Do You Trust Algorithms?
First of all, what is a robo advisor? Well, the idea of robo advisors is based around a few basic central principles:
- Investing should be low-cost
- Investing should be transparent
- Investing should be automated
Robo Advisors – Do You Trust Algorithms?
You have likely seen the stats before. On average, actively managed funds trail their passive counterparts across almost all fund categories. That means that the low-cost, low-touch S&P index ETF is likely to perform better than that massively loaded fund with the huge financial advisor fees on top which the guy on the radio has been trying to sell you. And that’s based on the fund performance BEFORE you take out any of those astronomical fees!
So that’s principle one: Investing should be low-cost.
As far as transparency, it is likely that you don’t know much about the companies your guy is trading in and out of that actively managed fund with the >100% turnover rate. If your guy is no longer keen on any of the stocks he owned in the fund just twelve months before, doesn’t that tell you something about his powers of prediction? Even if you had questions for your financial advisor, those would often go without an acceptable answer.
On the other hand, when you purchase an index mutual fund or ETF, it is usually pretty clear about what you are getting; for instance, a fund representing the composition of the S&P 500.
There is no room in there for any shenanigans involving a broker pushing a stock for which he has an ulterior motive to sell and certainly no “betting” on particular favorites. And most consumers don’t even know what to ask a financial advisor and just defer to the “experts.”
With investors increasingly uncertain about the quality of their retirements, people are looking for common sense solutions to their investing problems and don’t want to gamble away their previous pennies. Robo advisors are designed to increase transparency by eliminating any potential biases or conflicts of interest.
The third principle is that of automation, which brings us to your first important question: do you trust algorithms?
Consumers are increasingly comfortable using the Internet to meet all of their needs. From food and grocery delivery, to hotel and flight bookings, to dating and education, and now robo advisors. There is not an industry in the world that hasn’t been disrupted to some extent by the advent of the World Wide Web.
That being said, there are still a number of people who might book a holiday over the Internet, but they don’t want to turn over tens or hundreds of thousands of dollars to an investment advisory algorithm.
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This is a personal decision that you will have to make for yourself. One thing to keep in mind is that, as long as you are working with a reputable firm whose philosophy you agree with on all the big financial questions, you can be sure that you will be operating within the confines of that company’s philosophy.
There will be no rogue traders or anyone trying to pressure you into buying into the latest hot stock, even if you believe, for example, that index investing is the best way to go.
If you don’t fully trust in the robo advisor but want some automated advice, Vanguard is now offering what it calls Personal Advisor Services. After answering 15 questions online, the algorithm will suggest a portfolio for you, which will be customized and tweaked by a real-life investment professional. It’s a good alternative for those looking to mix human and robo advisors.
However, if you answered yes to this question, we can move on to boil down your choices of robo advisors. If you are not at all comfortable with having your investments operated by a machine, you should probably stick to a traditional portfolio manager or just invest in mutual funds or ETFs of your choosing, based on your own research.
Are You a Hands-on or Hands-off Investor?
As we have said, most firms use low-cost index funds as the basis for their robo advisors’ advice. But firms offer a varying degree of service that comes along with the service.
Some firms are fully automated. Two of the most well-known companies like this are Betterment and Wealthfront. They charge very low financial advisor fees but do not offer any personal contact. At many other firms, you can contact a real-life investment professional by phone, email or web chat if you have any questions about your investment portfolio.
Best Robo Advisor – Hands-off Investor
If this matters to you, it is one of the first things you have to think about.
Are you the type of person who freaks out when the S&P drops 1%? Will you go crazy and try to pull you money out right away? If you often have questions to ask a financial advisor, you might prefer an account with a more accessible human being who can talk you out of bad decisions and remind you of your investment philosophy when the going gets tough.
How Risky Are You?
When deciding what kind of portfolio to set up for you, your robo advisor will ask a number of financial questions. Key among these are questions about risk.
Depending on your risk tolerance, the best robo advisor may set you up with a bond-heavy portfolio, or it may toss you into mostly low-cap and international stock funds.
The aforementioned Wealthfront and Betterment platforms offer mostly traditional, “boring” ETFs, like the index funds offered by Vanguard.
These platforms are often better-suited to investors in their thirties or younger. The portfolios created by these robo advisors are usually heavy in stocks, designed with the hope that this will create a better long-term return for clients.
If you go with the robo advisors embedded in the traditional online investment platforms, like Schwab, Fidelity or E*Trade, you can get into a wider range of investment vehicles, including smaller funds and more actively managed funds.
For the extremely adventurous, there are options like Hedgeable. In addition to offering index funds and the like, Hedgeable also allows investors to buy alternative vehicles, like MLPs, gold or bitcoin, with relatively low financial advisor fees and expenses.
And for the extremely conservative, Schwab is probably a good choice. Every one of the financial advisory offerings made available on its Intelligent Portfolio platform keeps some portion of your investment in cash. This could be a great choice for those who are close to retirement or who just don’t feel comfortable with plunging too much capital into the market right now.
Do You Already Have Money in a Financial Services Firm and Don’t Want to Move Your Money?
This is straightforward. If you already have money in an online brokerage or a firm that has an online component, you likely already have access to some sort of robo advisor. Most investors like to keep as few accounts as they can, so that they can keep a better eye on the performance of their investments.
Ask your broker or peruse your firm’s website to see what kind of robo advisors it offers.
Is a Sleek User Interface or Mobile App Important to You?
Many users find this sort of thing actually motivates them to continue and even increase their investing habit. You can think of it as a sort of positive feedback loop, which can make one of these options the best robo advisor for you.
When waiting for the elevator, it’s easy to pop open one of these apps on your phone and quickly check out your robo advisor retirement accounts. For many users, this is highly motivating. They love to see their balance grow week after week, month after month, year after year.
A good app and interface can be more than just eye candy. This can be a real factor in determining which will be the most effective and best robo advisor for your specific needs.
There are also robo advisor companies that specialize in certain niches.
For example, Blooom will tap into your company’s 401(k) offerings and, based on your answers to a number of financial questions, advise you on which of those offerings you should be invested in.
No matter what your preference of investment vehicle, the timeframe you are focused on or your comfort level with fully autonomous robo advisors, there is a product out there today that can meet your needs.
The days of brokers cold calling investors to see how much business they can drum up is largely passing us by, and that’s mostly a good thing. As the robo advisor revolution continues and firms create more advanced algorithms and more sophisticated interfaces, the average investor will begin to look like an expert.
These days, you don’t need to pore over the stock charts every day to see if you can retire at your target age. The Big Data revolution has allowed programmers to create algorithms to predict the perfect portfolio for you based on answers to a few financial questions.
It’s up to you whether you want to fully run with it. At least stay open-minded about robo advisors in the future – the algorithms are getting better every day.
The simple fact is that investment advisory software being developed now can process far more information in a few seconds than even the best fund manager could in an entire lifetime.
So, in the final analysis, which of those two would you rather take advice from?
It seems things are only going in one direction as far as automated investing is concerned. However, as you can see, not all robo advisors are created equal.
Pick the one that is right for you.
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