With new advancements in technology, the popularity of automated investment advisors has increased. They are viewed as a low-cost and minimum-effort alternative to traditional advisors. However, enlisting a robo advisor may not be the best solution for every investor. According to a Massachusetts Securities Division policy statement, "fully automated robo-advisers, as currently structured, may be inherently unable to carry out the fiduciary obligations of a state-registered investment adviser."
Here's what you need to consider when deciding what the right option is for you:
Robo advisor vs. traditional advisors
Robo advisors build and manage investment portfolios using established algorithms. These systems will determine the best asset mix based on your timeline, risk tolerance, and other parameters you provide.
Traditional advisors or financial planners help you paint a more comprehensive picture of your financial situation. You may hire a financial professional to help you on an ongoing basis. They will guide you in making appropriate financial decisions and help with complicated topics such as developing tax strategies and estate planning.
Reasons to consider working with a robo advisor
Many robo advisors focus on passive investment strategies that combine the Modern Portfolio Theory (MPT) and the Efficient Market Hypothesis (EMH). By presenting a series of questions that measure your risk tolerance, robo advisors use your answers to these questions to develop a customized investment strategy. Instead of aiming to beat the market, robo advisors try to stay consistent with market returns over time. This strategy allows investors to take a hands-off approach to build their portfolio and manage their money.
This approach may also save investors money in the long run. Traditional advisors charge fees ranging anywhere from 1% to 3% of your assets to manage your funds, thereby impacting the return on your portfolio. With their passive investing methods, robo advisor fees tend to be a fraction of the expense associated with traditional advisors. The reduced cost of a robo advisor can potentially generate a much higher return on your investment.
Additionally, robo advisors tend to have lower investment requirements. If you find you don't meet the minimum requirements of a traditional advisor, working with a robo advisor may be a suitable solution. Some traditional advisors require $200,000 to $1 million to open an account. Conversely, numerous robo advisors allow you to open an account with no initial balance.
It's important to note that robo advisors were introduced during 2008's financial crisis and haven't been around that long. This means they may have limitations in their capabilities and performance. When deciding to work with a robo advisor, it's best to maintain realistic expectations.
Robo advisors don't excel at full-scale financial planning since the simple questions asked at the beginning of the process can't catch subtleties that would be covered in conversation with a human advisor. For instance, robo advisors don't factor in all the assets held by a customer into their investment analysis.
Reasons to consider working with a traditional advisor
Traditional advisors offer a more personalized experience for their clients and can provide better large-picture financial planning. They take into account issues that may not be covered in the quick financial analysis conducted by robo advisors, such as needing to care for a sick family member, possible assets inherited in the future, or other unexpected situations.
When working with a traditional advisor, you may have the opportunity to tailor your asset mix to your specifications. Robo advisors generally don't have as much flexibility with selecting specific investments for your portfolio. If you like to have more control over your assets and how they're invested, a traditional advisor could be a better option.
Making financial decisions and weathering through market volatility can be tough without having someone to help you navigate. A traditional advisor provides guidance throughout your financial journey. They help you see how your financial decisions will impact your future and help you reach your goals and objectives.
Accounting for the numerous aspects of your financial life can be complicated and confusing. Traditional advisors have the experience and knowledge you need to help you plan for the long-run. If you want to work with someone in person and receive a customized experience and you don't mind the extra cost, a traditional advisor is the way to go.
The bottom line
Selecting a method of financial advisement is an important decision. Robo advisors and traditional advisors have many different pros and cons. Before you select either option, take your time, complete your research, and determine which type of financial advisor will best suit your needs. Be sure to compare costs, asset allocations, minimum investment requirements, and any other prerequisites you desire.
If you think starting with an online stock brokerage firm or a robo advisor may be the right option for you, check out our top companies for 2019.