Robo-advisorshave been on the scene for a few years now, thanks to pioneering companies likeWealthfrontandBetterment. One of the key marketing strategies for these digital advisors is to market themselves as democratizing investing, making it more accessible for beginner and lower net-worth investors.
Not surprisingly, many of these are young investors, who are often digitally savvy and comfortable with using technology. So, it should come as no surprise that brokerages and financial firms target Generations X, Y and Millennials.
Key Takeaways
- Robo-advisors are automated investment platforms that offer very low fees and allow for low starting balances.
- As a result, these services are attractive for beginning investors, specifically younger ones who are just getting started.
- If you're new to investing, it helps to compare what robo-advisors and traditional advisors bring to the table. Weigh the costs and benefits of each before making your choice.
What Robo-Advisors Do for You
Before 2010, you had two options for executing your investing strategies—do it yourself or hire a financial advisor.
Investors of all experience levels can become overwhelmed, make mistakes. or give in to their emotions during downturns. Traditional financial advisors charge fees many younger or new investors might not be able to afford—and there's no guarantee that your advisor will get you the results you want, either.
Robo-advisors appear to be making it easier for people to invest. They automate trading decisions, eliminate human emotion from the equation, and offer very low fees—often, there are low minimum balances to get started.
Young investors, financial advisors, and even large companies like Vanguard and Fidelity have jumped in on the trend. However, robo-advisors are certainly not without their critics. It's still unclear how well artificial intelligence can execute strategies and maintain a portfolio's value in the long run.
Financial technology is continually under development, with new ideas emerging all the time. Robo-advisors are software that require updates and maintenance; they also may have new abilities introduced every few months. So if you choose one, make sure you stay up-to-date to get the most from it.
The Benefits of Robo-Advisors
It's becoming clear that robo-advisors have many benefits, especially for younger investors, many who are at an early stage in their investing lives.
Easy to Use
First and foremost, they are easy to use, and most of their user interfaces (UI) are very intuitive.
For example, Betterment's UI allows you to set up your retirementgoals and contributions within minutes—you can even choose from cryptocurrency portfolios. The process of transferring your retirement plan from another institution into Betterment is also straightforward. Further, the use of automation also ensures that you are making contributions. In many ways, you can set it and forget it.
Convenience of Doing Everything Online
Times are changing. Not everyone likes interacting with people. Younger people especially prefer and are used to doing everything online. Robo-advisors help cater to that. You don’t need to visit or talk to a financial advisor in person. You fill out some forms, and they do the rest.
Can Invest Small Amounts
Another reason robo-advisors are attractive is that you can invest whatever you have. Got an extra $20 leftover this month? You can easily deposit it into your account and invest it. Previously, the amount required for accessing certain funds was out of reach for certain income levels. Some robo-advisors require low minimum contributions, such as between $1,000 and $5,000—but several have minimums that range between $1 and $100.
Lower Fees
Perhaps a robo-advisor's most compelling aspect is the lower fees. Many offer free trades and no transaction fees. These two fees alone could cost you thousands of dollars if you were doing it yourself. However, they tend to charge an annual management fee based on assets held—generally between 0.25% and 0.50% per year. Compared to the 1% or more charged by human advisors, robo-advisors may feel like a bargain.
Some People Prefer Robots
For many people, the thought of having a machine managing your money is scary. Not everyone feels that way, though. Some investors, particularly younger ones, are said to trust robots more than human financial advisors. Stories of scandals have spooked them and they view machines as less corruptible.
Looking After Your Money
The best robo-advisors may also offer services like tax-loss harvestingand automatic portfolio rebalancing. These services were formally reserved for the high-net-worth clients of elite financial advisors—but robo-advisors have given average investors access to these strategies.
When you're choosing a robo-advisor, be sure to find out how it avoids conducting wash sales—selling assets for a loss then repurchasing them with similar ones at an even lower cost 30 days before or after the sale.
Some financial planners agree that robo-advisors have some significant advantages. Regular rebalancing requires substantial effort on the part of whoever is managing the portfolio. Digital advisors remove the hours of research, monitoring, and trading you might spend on your investments without them.
Other Robo-Advisor Considerations
No matter how hyped-up artificial intelligence is, it cannot fully replace a human. Yes, it can help lower costs and lower the entry barriers for young investors, but can you get a return on your investment?
Robo-advisors are still new in comparison to traditional methods of investing. They first appeared in the 2010s, so they have weathered market fluctuations but no deep recessions. Additionally, robot-advisors' ability to combat rising inflation is still being studied.
If you're new to investing, consider talking to an advisor or taking a beginning investor course so that you can understand the jargon and concepts used in the industry. Robo-advisors are generally beginner-friendly, but they still use the financial industry's language and terms.
So far, returns have varied widely depending on the robo-advisor and the portfolio. According to The Robo Report by Condor Capital, at the end of 2022, the five-year annualized trailing return for robo-advisors with portfolios with a 60/40 allocation ranged from 2.84% to 5.12%. They are not exactly mouth-watering figures, although there was a lot of volatility in that time frame and bonds have underperformed in recent years.
The data do not indicate future performance, but it does suggest that robo-advisors can be programmed to preserve capital and generate returns during chaotic economic and market circ*mstances. The caveat in this data is choosing a portfolio through your robo-advisor designed for dealing with these events.
The Hybrid Option
Brokerages have also started to cater to investors who prefer to talk to a human advisor while using a robo-advisor.
A hybrid robo-advisor is a platform that seeks to combine the benefits of automated investment with human financial advice. Your money is essentially invested by a robo-advisor using algorithms. However, you also have the opportunity to speak with a human financial advisor via phone or video calls for guidance and advice.
This could be a good choice if you've just started investing and need some advice while managing your finances through technology. Having a real financial advisor on hand obviously will come at a higher cost. However, not as much as if you commissioned one to do everything for you and met up in person.
Financial Advisors for Young Investors
A common complaint in the past was that financial advisors would not work with younger investors because they didn't have enough assets. Likewise, young investors found financial advisors too expensive.
Organizations like XYPlanning Network have helped bridge the gap between advisors and young clients by creating a database of fee-only advisors who will work with Gen X, Y, and Millennial investors.
You have more options than ever before when you're planning retirement and building your portfolios. Robo-advisors can undoubtedly be a good option, but you shouldn't be wholly opposed to hiring a financial advisor—especially if you're just getting started.
Why Are More Younger People Using Robo-Advisors?
Robo-advisors are believed to appeal more to younger people because this demographic tends to trust robots more and prefers doing everything online. Robo-advisors are also more accessible in terms of cost and the amount you can invest.
Who Is a Robo-Advisor Best Suited For?
Generally speaking, robo-advisors cater to people who need help investing, have fairly straightforward goals, and aren’t bothered about having little to no human interaction. Investors who have complex needs and want someone to talk to for guidance and advice may be better off paying more for a financial advisor.
Do Robo-Advisors Beat the Market?
Robo-advisors usually aren’t associated with bumper returns. They tend to invest across different asset classes, limiting returns but also risk. And when they invest in stocks, they tend to do so by investing in the entire market or sectors via ETFs that track indexes.
The Bottom Line
Robo-advisors tick a lot of the right boxes. They are cheap and eat less into investment returns, easy to use, highly flexible, and super accessible. That has made them popular, especially among younger investors who could do with a hand but perhaps cannot afford a financial advisor or do not fully need one.
Research also shows that many of the factors that put people off robo-advisors may actually appeal to younger people. One of the biggest criticisms of robo-advisors is the fear of handing your money over to machines. Artificial intelligence looks amazing, but to many people entrusting your money to robots is maybe a step too far. A lot of younger investors don't feel that way. They are less skeptical of technology, like doing everything online, and, in some cases, actually trust robots more than people.
