Would you trust your hard-earned savings on a robot investment advisor? It seems that about $3 billion+ in assets under management with various robo investment advisory firms is proof that investors, to some degree, have enough trust in them, thus far. In fact, large brokerage firms like Charles Schwab recently introduced its own version of these so-called “Robo” investment advisory services and has taken in more than $1.5 billion in a very short period. There have been numerous articles written about them, but I believe these types of firms are still relatively unknown to the average person.
What are Robo advisors and are they appropriate for investors?
What Are Robo Advisors?
The best way to describe robo advisors is to think of them as purely investment management firms that offer little-to- no human contact. They are essentially online-oriented firms that work with investors on their web sites. Each prospective customer must complete due diligence questionnaires before any money is invested. Most of the questionnaires are focused on obtaining information about risk tolerance, comfort with various asset classes, investment goals, how much they can initially invest, and how much they may need to withdraw or invest periodically.
Based upon the responses, the firm generates an initial investment allocation of stocks and bonds, using mostly low cost index funds and/or Exchange Traded Funds (ETFs). Once a prospective client agrees to move forward, the money is managed using the proposed allocation and is rebalanced regularly to ensure the allocation stays intact.
The big mousetraps of these firms are their low ongoing management fees (which are generally below 0.50% annually), very low initial investment thresholds, and their use of low-cost index investments. I liken them to low cost target-date, or lifecycle mutual funds that you see in many 401(k) plans. They automatically rebalance each year (or quarterly) and have the assets spread across various asset classes and market sectors. Firms such as Betterment, Wealthfront, and Schwab’s Intelligent Portfolios are similar in their data gathering and investment process, though their recommended investment allocations can be very different.
But, Are They Right for You?
Most people I talk to would be hesitant to hand over money to a firm that does not provide any human contact. For many people, having a relationship with a human advisor is valuable and irreplaceable. As an example, our firm provides investment management services, but we also complement it with financial planning ranging from comprehensive retirement analysis to estate planning. Most of the robo advisors I’m aware of do not partake in these services, and are purely investment driven. They will compete with each other on cost since they generally use principles of asset allocation. It’s important for people interested in robo advisors to be aware of this because you will be on your own and will not be able to discuss your portfolio or any other matter in any great detail with anyone. As far as I know, robots are not capable of handling financial issues.
Similarly, we’ve been in the one of the strongest market advances in recent memory, and we’ve not had a major correction in nearly four years. A portfolio that is essentially on autopilot with a robo advisor looks good during good times, but what happens when the bear strikes again, and we know that it will? How are customers of these robo services going to behave during less attractive markets?
My Criterion for Picking a Human or Robo Advisor
- You want a “high-touch” approach to financial advice: Human
- You care about reaching quantifiable goals and objectives: Human
- Your behavior during turbulent markets causes you to sell out of stocks: Human
- You want to be somewhat involved in the process: Human
- You don’t care about anything other than investing money: Robo
- I want the cheapest investment costs possible: Robo
My sense is, some of these robo advisors are going to realize they need to offer more than just plain vanilla investment management if they want to keep their customers from leaving, and it will put pressure on them to possibly raise fees down the road, but they are not there yet. I am already seeing some investment advisers incorporate their own version of robo services in their practices, though they would be focused primarily on helping investors will less complicated personal circumstances.
For now, these robo advisers are attracting assets because of their simplicity, low costs, and technological presence. But the proof will be in the pudding long-term, when I predict you will see robo investors realize that a “machine” can’t replace the value of a human, professional advisor.
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