One of the most frequent questions we are asked is "What is a roboadvisor and how can it help me?" Surprisingly (or perhaps not surprising at all), many people we speak with have never heard of the term at all. That is why we are here. To inform, educate, question, improve, and offer advise on how to utilize this growing service. To do that, lets start at the beginning.
What exactly is a roboadvisor? The general definition is as follows:
Robo-advisor- a type of financial advisor that utilizes technology to generate financial plans and investment advice with limited human interaction.
So what does this mean and how does it work?
At the most basic level, those seeking financial advice fall into three buckets.
A - Is looking for a financial plan - to set up a budget, save for a house and children's college education, as well as retirement planning
B. - has money and needs advice on how to invest it
C. Some combination of the two
To meet the needs of these individuals, there are thousands of firms that fit the following criteria:
Financial planners do just what they sound like. Much like getting on a workout plan to lose weight, a financial plan helps you achieve your financial goals: retirement planning, buying a house, etc.
How it works: A planner will meet with you to discuss your goals as well as other financial aspects of your life such as your income, expenses, what you currently have saved, etc. They are then tasked with determining the type of risks you would take to meet these goals. Based upon these inputs, the advisor will formulate a plan to help you achieve your goals. This plan would include a budget as well as goals of what you need to save and how to invest your savings, known as your asset allocation. Essentially your life is one giant math equation. A financial planner will help you take all of your variables and generate an action plan (yes, an actual physical plan for you to hold) on how to achieve them. It is then up to you to implement and stay on the plan.
The pros: You work with a knowledgable individual who knows laws, tax code, proper investment vehicles, and how to plan out your financial goals. This math equation is too complex for most individuals to successfully complete on their own so working with a professional is becoming more necessary.
The cons: While potentially a great investment, this can be a very costly endeavor. Plans can cost thousands of dollars because of the time commitment required from the planner for each client.
Also much like it sounds, financial advisors give investing advice. Often they are given discretionary power to make trades and investments when they see fit. Pure financial advisors will formulate an investment strategy based upon your needs, wants, and abilities and willingness to take risk. In its simplest form, you can take $100,000 to a Registered Investment Advisor (RIA), sign some documents, and have the firm take control over the management of your assets. You pay either a commission or a yearly fee based upon the size of your assets.
The pros: Properly investing assets requires the use of a professional. While you see commercials portraying stock investing as easy and fun (think a funny baby who loves trading), the investment management industry wouldn't be around if it was that easy (after all, that baby's company is getting paid for each trade made). Furthermore, you can generate a lot of wealth if you are able to find the proper investment manager.
The cons: There are thousands of options to choose from which can be overwhelming. Firms of all shapes and sizes appear to offer sound investing advice with differing approaches, fee structures, and varying success rates. Fees can be quite costly to compensate for active management. Also, while finding the right investment manager can help yuo build a lot of wealth over time, most money managers underperform their benchmark after fees.
The Next Generation
So, we have established that there are positives to hiring professionals for financial services such as planning and asset management. However, we have seen that both services also have downside issues. Surprisingly, even with the issues that we presented, there has been limited innovation in this inudstry until recently.
As technology has evolved, solutions have been created to mitigate these risks. The roboadvisory industry was founded around this thought: If you can take much of the human interaction out of the equation, you can not only increase your scalability, but you can also decrease the cost to the end consumer. And so, technology-based financial planning and investment management was born.
This is all possible due to complex algorithms that can crunch the data that the customer inputs about their current situation. Using Modern Portfolio Theory (a Nobel Prize winning theory on how to maximize returns for a given level of risk) and generally accepted financial principals, rules-based advice can be created. After all, a live financial planner is doing the same calculation, only manually. This is time consuming and costly.
Is a robo-advisor right for you?
Overall, there are pros and cons to the robo-advisor industry and it depends on the individual if a robo advisor is right for them. For someone without a current advisor or those looking for a low-cost option, robo-advising may be a great fit. You can get the advice you will need for minimal cost. However, those with more complex situations may need the added attention of a dedicated financial planner of investment advisor to help them manage their special circumstance. Certain individuals will want to pay for the added benefit of having a live person to speak to while others may be averse to speaking to anyone at all.
Check out more articles written here at RoboRiches in our archives.
There are many roboadvisors to choose from; each with distinct characteristics and a wide variety of services offered. We break down the similarities and differences between these firms here at The List.