Robo-advisors can be an easy way for beginners to get started on a safe and sensible investment plan without needing to do any research, or make too many decisions.
Robo-advisors are software programs that use a complex algorithm to build a balanced portfolio of stocks and bonds for each investor. The robo-advisor bases its choices on the answers to a series of questions assessing the investor’s risk tolerance and financial goals. As market conditions change, the robo-advisor rebalances investments as necessary to optimize returns and minimize exposure to risk.
From low barriers to low fees, there are certainly plenty of positives when it comes to using robo-advisors. Even so, robo-advisors have some limitations, and aren’t the best answer for many investment situations.
If you’re interested in learning more about robo-advisors, here’s a closer look at what to like, and what to look out for.
If you want to invest but don’t want to have to pay for expert advice, robo-advisors offer peace of mind for a low price. With most robo-advisors, the fees are about a quarter of those charged by human advisors, a significant savings that adds up over time, and makes a big difference to someone just starting out as an investor.
Many of the top human financial advisors prefer to only work with healthy investment funds. Robo-advisors don’t demand that you bring big wealth to the table, with most starting minimum balances ranging from a few hundred to a few thousand dollars. They’re ideal for younger investors who want to get going on building a portfolio without doing a ton of research, or paying for expert advice.
One of the pitfalls of any investment strategy, but especially DIY investing, is letting emotion cloud your judgement and making rash, regrettable decisions. A robo-advisor doesn’t do that. It doesn’t even try to ‘beat the system’ and pick big winners. In some ways, it’s the perfect, rational investor. It just makes safe, low-risk buys, over and over and over again. Every once in a while, it’ll rebalance for you by selling high and buying low. It’s not flashy, but it is effective.
Without human input, your portfolio isn’t truly ‘personalized’
There’s no denying that the algorithms behind robo-advisors are smart. Nevertheless, a few questions about goals and risk tolerance, while undoubtedly important, can’t be used to create a truly personalized investment plan that accounts for every aspect of each person’s unique situation.
We all have different needs and goals, we all face different demands, and we all have different tolerances for market swings. When tough times hit, or we need answers to troubling questions, there’s a lot to be said for having a human being to talk to, someone who understands your personal situation and how that impacts your needs and decisions.
Robo-advisors allow investors to purchase stocks and bonds, but typically don’t allow investors to choose specific stocks. Some types of transactions and financial assets simply aren’t available using robo-advisors. As wealth grows and an investor’s needs become more complex and varied, robo-advisors don’t always offer a complete range of financial options. In such situations, the ability to discuss matters with a human advisor is often beneficial, providing access to a broader selection of choices and alternatives that robo-advisors don’t offer.
They don’t always beat their benchmarks
Research shows that while robo-advisors reliably generate returns, those returns haven’t always exceeded the software’s benchmark. In an August 2021 study, all 20 robo-advisors examined by Backend Benchmarking had positive three-year returns, but only four beat their benchmark over that span.