If you have recently researched investment management services, chances are that you have come across the term “robo-adviser.”
Who are these robo-advisers and can you trust them with your financial future?
A robo-adviser is an online investment platform that uses algorithms to determine asset allocations for investors and manages their investment dollars with minimal human intervention. Because they utilize technology rather than active management by a human, robo-advisers charge significantly lower fees than what most financial advisers typically charge.
“It’s a fast growing business today, with something close to $20 billion in assets under management,” says David Larrabee, director at CFA Institute, the association of investment professionals. “Robo-advisers are here to stay and have demonstrated there is demand.”
According to recent research by A.T. Kearney, approximately $2 trillion will flow into robo-adviser platforms over the next five years.
What is driving the explosive growth in the robo-adviser marketplace? Experts point to the demographics, account sizes, and low costs as the main factors.
Demographics: Investors of all ages are using robo-advisers, but not surprisingly, they are especially popular among millennials and Generation Xers who grew up with technology and would feel just as comfortable firing off an email or texting as they do talking to a human being.
Lower account minimums: Furthermore, most wealth management firms require investors to have a minimum of $100,000 or more in investable assets. Robo-advisers have investment minimums in the low four-digit numbers; some have none. “The traditional investment advisory accounts’ minimum of $100,000 puts [traditional] advisers out of reach for a lot of investors,” says Larrabee. “Robo-advisers are stepping up to fill that void.”
Lower fees: Last but not least, robo-advisers are inexpensive. While traditional wealth management services charge 1 percent of assets under management or more, the typical fee charged by a robo-adviser is 25 basis points or lower, depending on account size.
How Robo-advisers Work
With a robo-adviser, clients open an account and typically start by answering a series of questions about their age, tolerance for risk, and investment goals. The platform provides an asset allocation based on their answers. An older investor nearing retirement, for example, will be recommended a more conservative asset allocation than a younger investor who will be working for decades to come.
Low-Cost Index Investing Keeps Emotions Out of Your Investment Strategy
Robo-advisers typically don’t trade individual stocks or offer specific stock trading advice. Rather, they tend to invest in low-cost ETFs, which provide instant diversification, as well as tax efficiency.
Most robo-advisers adhere to a buy-and-hold, passive investing strategy. They don’t pick stocks or try to time the market. Instead, robo-advisers are charged with figuring out the exposure investors should have to stocks, bonds, international investments, and other asset classes, and use each individual investor’s age, expected retirement date and risk profile to come up with an asset allocation and stick to it, regardless of day-to-day market movements.
Account Rebalancing Keeps Your Investment Goals on Track
Although robo-advisers do not react to stock movements, they do track the markets on a daily basis. If market swings move clients’ portfolios out of balance with respect to their recommended asset allocation, they rebalance accordingly, while being mindful of creating taxable events or incurring trading fees.
As a result, investors with these platforms do not have to get on the phone with their money manager if one company is driving an entire sector down. They can rest assured that, provided that they are in a properly diversified portfolio, they will be able to stay the course and ride out any market downturn.
Investors who need estate planning or have complex investment portfolios may want the hand-holding that comes with a financial adviser, or simply find a good lawyer and then choose low-cost index funds or ETFs on their own. For many investors, however, robo-advisers offer a way to grow their investment nest egg without getting hit with high costs and fees.
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