Are Robo-Advisors Safe and Worth It?

By MP Dunleavey · January 06, 2022 · 6 minute read

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Are Robo-Advisors Safe and Worth It?

When robo-advisors first appeared on the financial scene nearly 15 years ago, they were a novelty. Now these automated portfolios have become a staple offered by numerous financial companies, providing many people with a reliable, cost-efficient way to invest for retirement and other goals — while helping to manage certain market and behavioral risks.

Because robo-advisors typically rely on sophisticated computer algorithms to help investors set up and manage a diversified portfolio, some have questioned whether technology alone can address the range of needs that investors may have over time.

Others note that the lower fees and lower minimum balance requirements typical of most robo-advisors, in addition to the automated features, may provide a much-needed option for new investors. Could a robo-advisor be the right choice for you? It helps to understand how they work in order to weigh the pros and cons.

Is a Robo-Advisor Right for You?

Robo-advisors typically use artificial intelligence to create retirement and financial planning solutions that are tailored to people’s individual needs. Here are some questions to ask yourself, when deciding whether a robo-advisor is right for you.

How Does a Robo-Advisor Pick Investments?

While the term robo-advisor can mean different things depending on the company that offers the service, investors usually fill out an online questionnaire about their financial goals, risk tolerance, and investment time frames. On the back end, a computer algorithm then recommends a portfolio of different securities based on those parameters.

For example one person may be investing for retirement, another saving for the purchase of a home. Depending on each person’s preferences, the robo-advisor generates an asset allocation that aligns with their goals, or suggests portfolio options they can choose from. A portfolio for someone nearing retirement age would typically have a different allocation versus a portfolio for someone in their 20s, for example. Depending on these details, the service might automatically rebalance the portfolio over time, execute trades, and may even conduct tax-loss harvesting.

Can I Choose my Own Investments?

To a limited degree, yes. A robo advisor typically has a range of investments they offer investors. Usually these are low-cost index ETFs, but the offerings can vary from company to company. In most cases, though, your investment options are confined to those available through the robo-advisor.

As the industry grows and becomes increasingly sophisticated, more companies are finding ways to offer investors new options like themed ETFs, stocks from different market sectors, socially responsible investing options, and more.

Who Manages the Portfolio?

Part of the appeal for some investors is that these portfolios are automated and require less hands-on involvement. This may be useful for people who are new to the process of setting up and managing a diversified portfolio, or who don’t feel comfortable doing so on their own. In some cases, a robo-advisor service may also offer a consultation with a live human advisor.

That said, in most cases robo-advisor services are somewhat flexible. Even though you’ve set up an automated plan, it’s still possible to change your asset allocation if your preferences change.

Recommended: Robo Advisors vs. Financial Advisors

Are There Risks Involved in Using a Robo-Advisor?

Investment always involves some exposure to market risks. But robo-advisors may help manage behavioral risk. Many studies have shown that investors can be impulsive or emotional when making investment choices — often with less than optimal results. By reducing the potential for human error through the use of automation, a robo-advisor may help reduce potential losses.

What do Robo-Advisors Cost?

While there are some robo-advisor services that have higher minimum balance requirements or investment fees, the majority of these services are quite cost efficient. In some cases there are very low or no minimums required to set up a portfolio. And the management fees are typically much lower than what you’d pay for a human advisor. With SoFi’s automated investing feature, for example, you can get started with as little as $1 and you don’t pay any SoFi management fees (although there are typically fees or expense ratios associated with the investments in the portfolio).

Pros and Cons of Robo-Advisors

Hopefully, the questions above have clarified the way a robo-advisor works and shed some light on whether a robo service would be right for you. In addition, there are some pros and cons to keep in mind.

Pros of Robo-Advisors

Saving for Retirement

It’s true that you can use a robo-advisor for almost any short- or long-term goal — you could use a robo-advisor to save for an emergency or another savings goal, for example. But in many ways these services are well-suited to a long-term goal like retirement. Indeed, most robo services offer traditional retirement accounts like regular IRAs, Roth IRAs, SEP IRAs.

The reason a robo-advisor service can be useful for retirement is that the costs might be lower than some other investment options, which can help you keep more of your returns over time. And the automated features, like portfolio rebalancing and tax optimization, can offer additional benefits over the years.

Typically, many robo portfolios require you to set up automated deposits. This can also help your portfolio grow over time — and the effect of dollar cost averaging may offer long-term benefits as well.

Diversification

Achieving a well-diversified portfolio can be challenging for some people, research has shown, particularly those who are new to investing. Robo-advisors take the mystery and hassle out of the picture because the algorithm is designed to create a diversified portfolio from the outset; you don’t have to do anything. In addition, the automatic rebalancing feature helps to maintain that diversification over time — which can be an important tool to help minimize risks. (That said, diversification itself is no guarantee that you can avoid potential risks completely.)

Automatic Rebalancing

Similarly, many investors (even those who are experienced) may find the task of rebalancing their portfolio somewhat challenging — or tedious. The automatic rebalancing feature of most robo-advisors takes that chore off your plate as well, so that your portfolio adheres to your desired allocation until you choose to change it.

Tax Optimization

Some robo-advisors offer tax-loss harvesting, where investment losses are applied to gains in order to minimize taxes. This is another investment task that can be difficult for even experienced investors, so having it taken care of can be highly useful — especially when considering the potential cost of taxes over time.

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Cons of Robo-Advisors

Limited Investment Options

Most automated portfolios are similar to a prix fixe menu at a restaurant: With option A, you can get X, Y, Z investment choices. With option B, you can get a different selection, and so on. Typically, the securities available are low-cost, index ETFs. It’s difficult to customize a robo account; even when there are other investments available through the financial company that offers the robo service, you wouldn’t have access to those.

In some cases, investors with higher balances may have access to a greater range of securities and are able to make their portfolios more personalized.

Little or no Personal Advice

The term “robo-advisor” can be misleading, as many have noted: These services don’t involve advice-giving robots. And while some services may allow you to speak to a live professional, they aren’t there to help you make a detailed financial plan, or to answer complex personal questions or dilemmas.

Again, for investors with higher balances, more options may be available.

Performance

Robo-advisors have become commonplace, and they are considered reliable methods of investing, but that doesn’t mean they guarantee higher returns — or any returns. We discuss robo advisor performance in the section below.

Robo-Advisor Industry

Robo-advisors have grown quickly since the first companies launched in 2008-09, during and after the financial crisis. Prior to that, financial advisors and investment firms made use of similar technology to generate investment options for private clients, but robo advisers made these automated portfolios widely available to retail investors. The idea was to democratize the wealth-management industry, by creating a cost-efficient investing alternative to the accounts and products offered by traditional firms.

Today, the robo adviser market is worth about $1 trillion (estimates vary), and there are dozens of robo-advisors available — from independent companies like SoFi Invest®, Betterment, blooom, and Ally, as well as established brokerages like Charles Schwab, Vanguard, T. Rowe Price, and many more.

While these figures are still miniscule compared to the $100 trillion in the global asset-management industry, robo-advisors are seen as potential game-changers that could revolutionize the world of financial advice.

Because they are direct-to-consumer and digital only, robo-advisors are available around the clock, making them more accessible. Their online presence has meant that the clientele of robo-advisors has tended to skew younger.

Also, traditional asset management often have large minimum balance requirements. At the high end, private wealth managers could require minimums of $5 million or more.

The cost of having a human financial advisor can also drive up fees north of 1% annually, versus the 0.25% of assets that robo-advisors typically charge.

How Have Robo-Advisors Performed in the Past?

Like any other type of investment — whether a mutual fund, ETF, stock, or bond — the performance of robo-advisors varies over time, and past performance is no guarantee of future returns.

Research from BackEnd Benchmarking, which publishes the Robo Report, a quarterly report on the robo-advisor industry, analyzed the performance of 30 U.S.-based robo-advisors. As of Sept. 30, 2021, the 4-year total portfolio returns, annualized and based on a 60-40 allocation, ranged from 6.51% to 10.98%. (Data not available for all 30 firms.)

Recommended: How to Track Robo-Advisor Returns

The Takeaway

Despite being relative newcomers in finance, robo-advisors have become an established part of the asset management industry. These automated investment portfolios offer a reliable, cost-efficient investment option for investors who may not have access to accounts with traditional firms.

Robo advisors don’t take the place of human financial advisors, but they can automate certain tasks that are challenging for ordinary or newbie investors: selecting a diversified group of investments that align with an individual’s goals; automatically rebalancing the portfolio over time; using tax-optimization strategies that may help reduce portfolio costs.

Curious to explore whether a robo-advisor is right for you? When you open an account with SoFi Invest®, it’s easy to use the automated investing feature. Even better, SoFi members have complimentary access to financial professionals who can answer any questions you might have.

Check out automated or active investing with SoFi Invest today.


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