Technology and innovation marches forward whether you want it to or not. In the finance and investment industry it has brought us the index fund, ETF’s and drastically lower commissions on brokerage trades. All of these are, without question, major positives for investors. More, and better, investment choices and lower costs are impossible to view in any way other than as a major coup for the investing public.
Recently, the intersection of lower costs and more choices has brought us robo-advisors, an innovation that some financial advisors claim is detrimental to investors. While robo-advisors, like all new technologies are imperfect, they have many positive attributes which we should all consider. Ultimately, however, we must weigh the pros and cons and ask ourselves, are robo-advisors as dangerous as some traditional advisors say or are these advisors just trying to protect their livelihoods by holding on to the past?
Let’s begin with a simple definition. A robo-advisor is a program that, without much, or any, regular oversight from humans, manages investment portfolios based on a predetermined set of rules – in other words a computer program or algorithm.
Wealthfront and Betterment are some of the more well-known, stand-alone robo-advisors. There are also a number of similar services rolled out by large, already established firms to compete with these and other upstarts.
Because of the large number of robo-advisors out there, with new ones continually being created, it is impossible to be too detailed with what they do well and what they don’t do well. All assertions made here will be generalities. Please understand that each robo-advisor is only as good as the underlying code that directs its actions or inactions. Additionally, these algorithms are proprietary software and will vary from company to company. As is the case with all advisors, whether automated or not, a good fit is of paramount importance. The ‘best’ advisor may not be a good fit for your needs, particularly if you have special circumstances that need to be considered.
With that disclosure out of the way, there are several things robo-advisors do well, particularly when considered against their competition – the traditional investment management model delivered by living, breathing people.
Cost
First and foremost among these advantages is cost. As with most things, technology can do things more inexpensively than humans can, or are willing to. This is great because it allows investors to keep more of their investment earnings by paying less to the advisors who manage them. While the general rule that robo-advisors are cheaper than traditional advisors holds true, it is not so in every case. There are expensive (some might say overpriced) robo-advisors, just as there are inexpensive traditional advisory firms like Scale Investment Group.
Another key component related to cost is the types of investment vehicles that are used. Most, but not all, robo-advisors use index funds which are typically much cheaper than actively managed funds. If your financial advisor, robo or otherwise, isn’t using index funds extensively, chances are you’re not only overpaying, but you’re also likely underperforming.
That is not to suggest that all traditional advisors use actively managed funds, however. At Scale Investment Group we not only use index funds extensively to keep costs down, we are also known for having among the lowest advisory fees in the business, comparable to, and even better than, many robo-advisors. We can compete with algorithms on cost because we are efficient in our operations, yet still provide the personal touch and customizability a computer program cannot. There are a handful of other firms that also do things similarly.
Objectivity and Efficiency
Objectivity is another oft cited benefit of robo-advisors. Humans tend to make errors, particularly when greed, fear or other emotions are involved. Advisors are not immune to this and examples of advisors caving to fear are numerous. Almost without exception these failures in objectivity (or perhaps more accurately described as a failure to have systematic processes in place) have cost clients dearly – we need look no further than the last recession to see advisors join their clients in panicking when they should have been steadfast and objective.
Robo-advisors usually get high marks for being tax efficient. Between using index funds (which themselves are fairly tax efficient investment vehicles) and the ability to harvest losses with which gains can be offset, robo-advisors are generally pretty good at keeping the tax man at bay. If tax management is an important consideration for you any advisor worth their salt should be able to provide a similar service where applicable. Additionally, for the tax conscious investor, an advisor should be able to craft a tax efficient portfolio using investments and strategies that may simply be unavailable with a robo-advisor.
Customization
The algorithms that are such a benefit to robo-advisors because of their objectivity can also be a major detraction when portfolio customization is required or when your financial situation changes significantly. Because they are typically fairly static, these computer programs often fail to be flexible enough when things need to change on the move. With traditional advisors this should be less of a concern as a portfolio can be re-worked when and if required. If you have a substantial, low cost basis position in a stock, or stock options from an employer, a robo-advisor may be unable to work around those constraints or the work around could have significant tax implications. Any situation that is out of the norm should be carefully considered with robo-advisors.
As with most things, it’s not all positives when it comes to robo-advisors (or advisors in general for that matter). One of the biggest drawbacks is that there is no customizability to the solutions they provide. It is a take it or leave it type of proposal. If you have unique circumstances or want to use certain specific funds you may find yourself out of luck.
Overall, for most people, robo-advisors are a great option and a relatively inexpensive way to get help with investments without having to meet sometimes unrealistic account minimums and pay premium pricing for average to below average advice. If you’re considering working with a robo-advisor, consider the potential cons and risks associated with this still relatively new way to manage money. Do your research and understand what you are getting and how much it’s costing you. The same advice holds doubly true when evaluating a traditional advisor.
Robo advisors are seen as a threat by many financial advisors I’ve spoken with – and rightfully so. As people get more comfortable working with technological interfaces in relation to personal one-on-one interactions they are more likely to accept an automated investment platform, such as a robo-advisor. Couple that with the fact that the systems underlying robo-advisor programs keep improving and too many financial advisors are too expensive and not delivering the results clients expect and you may just see a shifting tide in where and how people invest.
Add in the fact that most robo-advisors are significantly cheaper than your average advisor or broker and you have a very compelling case to embrace the new technology and ditch the traditional model. Of course, at Scale Investment Group we feel we have eliminated the primary advantage of robo-advisors – cost, while also being able to be flexible, which robo-advisors are not. While the rest of the industry, robo and traditional, struggle to fill the gaps in their services, we are already ahead of the curve solving client problems.