The Pros and Cons of Using a Robo-Advisor

The worlds of investing and wealth-building are constantly evolving. Technology infuses its innovative tentacles into every crevice of the industry. And though challenges and concerns do arise from time to time, the overall trajectory is encouraging. In many cases, new technology means lower fees, greater accessibility, and better investor-side control.

At the heart of this fintech explosion, you’ll find robo-advisors. Some call them controversial or risky, while others hail them to be the next great iteration in investing. But the big question most people are asking is, should I be using a robo-advisor as part of my wealth-building and investing strategy?

The answer is…it depends. It depends on a lot of unique factors and circumstances that can’t possibly be dissected with a high degree of accuracy in a single sweeping article. However, I would like to give you a basic breakdown of what a robo-advisor is, the typical advantages of using one, and some of the drawbacks or sacrifices that you’ll experience when using a robo-advisory-based investment platform.

What is a Robo-Advisor?

Robo-advisors are basically algorithm-driven financial planning tools that provide financial planning services with little or no human supervision. These platforms typically collect some information from the client about their current financial situation, their future financial goals, risk tolerances, and preferences. This information is then weighed against unpredictable and uncontrollable forces like market volatility and asset class performance to (ideally) create a portfolio that generates a healthy return on investment (ROI) without exposing the investor to unnecessary risk.

No two robo-advisors are identical. However, you’ll find that most of them operate in a similar fashion (at least from the user side of things).

1. The process typically begins with the investor completing a questionnaire about risk tolerance, time horizon, and financial goals.
2. Based on the inputs, the robo-advisor develops a tailored financial strategy and picks a targeted and diversified portfolio of funds that are most likely to help you reach your goals within a risk tolerance you’re comfortable with.
3. The robo-advisor works in the background, continually optimizing and rebalancing your portfolio to ensure it’s on track. With most robo-advisors, there’s also a team of experts overseeing market activity to ensure everything is on track.
4. Depending on the platform you use, you may also have access to live financial planners or investment experts who can serve as a system of checks and balances for the robo-advisor.
5. When there are life changes, simply log in, adjust your preferences, and the robo-advisor will respond accordingly.

Robo-advisors have been around in some form or fashion for more than a decade. However, they’ve only just become a mainstream option for investors.

Rewind to 2015 and robo-advisors were managing $47.3 billion in assets. By 2016, that number had more than doubled to $98.5 billion. By the end of 2022, it’s estimated that the more than 100 mainstream robo-advisor platforms on the web will oversee over $460 billion. That’s nearly 10x growth in a little under eight years.

The Pros of Using a Robo-Advisor

Robo-advisors aren’t just trendy pieces of tech – they actually pack quite a powerful punch. Here are some of the biggest advantages of using robo-advisors to manage some of your wealth and oversee your investments.

• Low investment minimums. Many financial advisors will refuse to work with a client unless they have six figures worth of assets. (Some even require a minimum of $1 million.) With robo-advisors, you’ll rarely find investment minimums. And if you do, they’re typically between $500 to $5,000. This makes robo-advisors more accessible to the average investor.
• Lower fees and costs. Perhaps the biggest appeal of working with a robo-advisor is the low fees. Every platform is different, but you’ll usually pay somewhere between 0.25 percent to 0.50 percent in the form of an annual management fee. Considering that most human advisors charge around 1.00 percent for managing assets, robo-advisors are considerably less expensive.
• Sophisticated investment models. Human advisors might have personal knowledge and experience, but robo-advisors are powered by sophisticated investment models that rely on millions of individual data points. Take Betterment, for example, which uses a Nobel Prize-winning investment theory as the foundation for their algorithm. I don’t care how smart a financial planner is – they don’t offer that kind of sophistication when building out a portfolio.
• Personalized approach. While you aren’t getting access to human advisors, robo-advisors do offer a very personalized approach in terms of how they optimize your portfolio to meet your individual needs, risk tolerance, time horizon, and goals.

The Cons of Using a Robo-Advisor

As convenient and effective as robo-advisors can be, I’m not going to pretend like they’re the be-all and end-all for investing. There are still some downsides and potential risks associated with using these sophisticated platforms. Here are several of the biggest cons.

• Limited personalization. As previously mentioned, robo-advisors offer a personalized approach in terms of portfolio construction. However, they aren’t 100 percent personalized quite yet. If you want to do things like sell call options or buy an individual stock, your robo-advisor might not be able to help you. A human advisor, on the other hand, has a lot more functionality and fewer limitations.
• Lack of human support. One of the benefits of working with a human advisor is the emotional support they provide when the market dips 12 percent and your retirement flashes before your eyes. Likewise, they can keep you grounded when the market is booming and it feels like everything you touch turns to gold. You don’t get that with a robo-advisor. This can be isolating and even dangerous to your financial decision-making.
• Limited track record. As sophisticated as robo-advisor algorithms are, most have only been around for a few years. Their limited track record might be good, but we’ve yet to see them perform over 10, 15, or 20 year stretches.

Is a Robo-Advisor Right for You?

Robo-advisors have their pros and cons. At the end of the day, it’s up to each individual investor to weigh these factors against each other to make an educated decision. And if you do decide to use a robo-advisor, it’s imperative that you take the time to select the appropriate platform.

If you’re looking for more insights on how to select a robo-advisor, I’ve written several in-depth guides that will help you compare some of the top options in a head-to-head manner:

• Acorns vs. Betterment: Which One is the Better Robo-Advisor?
• SoFi Invest vs. Betterment: Which Should You Choose?
• Wealthfront vs. Betterment: Which One is Best?
• Betterment vs. Robinhood: Which is Right for You?

There are plenty of good options to consider.

And if you’re hesitant to go all-in on robo-advisory, remember that you can take a hybrid approach.

Many of these platforms offer tiered services where you get access to both the robo-advisor and a live Certified Financial Planner. Try what makes you feel comfortable!