A robo-advisor is a wealth management platform that uses computer algorithms to select a mix of investments designed around your goals and risk tolerance. They also provide on-going portfolio maintenance such as rebalancing. Some of the larger robo-advisors include Betterment, Wealthfront, Schwab Intelligent Portfolios, and Vanguard Digital Advisor. Robo-advisors have a few major advantages, especially very low fees, but may or may not be the right fit for you. In this article, we’ll go over the main advantages and disadvantages of robo-advisors, and compare that to a more full-service financial planning firm like Facet.
What services can you expect from a robo-advisor?
Robo-advisors generally offer portfolio construction, rebalancing, and tax-loss harvesting, all executed automatically by computer algorithms.
- Portfolio construction: With a robo-advisor, you will typically answer a brief questionnaire to determine the right strategy for you. These are generally very surface-level questions, such as age, income, time to retirement or other goals, and some estimate of risk tolerance. From this basic questionnaire, the robo-advisor’s algorithm will select a portfolio from a set of strategies the advisor offers. Typically, robo-advisors use low cost exchange-traded funds or ETFs.
- Automated rebalancing: Robo-advisors use software to automatically buy and sell assets that drift away from the original target. This is meant to keep your overall risk exposure consistent over time.
- Tax-loss harvesting: This is a strategy where an investor sells funds in taxable accounts that decline in value and replace those funds with similar funds. Most robo-advisors offer this service.
- Cash management: Many robo-advisors have high-interest savings options for investing cash.
What are the advantages of a robo-advisor?
The primary advantage of using a robo-advisor is costs and extremely low account minimums.
- Fees: Since robo-advisors don’t have to hire human advisors to help you with your financial planning, they can afford to charge less than other kinds of advisors. Wealthfront and Betterment, two of the larger robo-advisors, both charge 0.25% of your assets per year for their primary advisor service. This compares to more like 1.00% for typical full-service advisors, according to NerdWallet. Facet charges a flat fee, which may or may not be more expensive than a robo-advisor depending on your account balance.
- Account minimums: You can typically open a robo-advisory account with very little initial investment. Fidelity Go only requires $10 to start investing. For investors just starting out, these low minimums are a key feature.
- Convenience: One of the advantages of hiring any kind of advisor is they take on the burden of handling all the trading and portfolio maintenance for you. A robo-advisor is no different.
- Fiduciary standard: Typically robo-advisors are Registered Investment Advisors, which legally binds them to act as a fiduciary. This means they must give advice that is in your best interest. While a robo-advisor may have limited knowledge of your personal situation, they are obligated to collect enough information to make a reasonably informed decision about what is best for you, even if it is ultimately an algorithm making that decision.
What are the disadvantages of a robo-advisor?
The main disadvantages of a robo-advisor are overly simplistic planning advice, static investment portfolios, and the lack of a human to talk you through more complex issues.
- Simplistic planning advice: Robo-advisors generally only offer very limited financial planning advice. They will create an asset allocation, which is a mix of stocks and bonds (or funds that invest in stocks and bonds). This is generally based on a basic overview of your goals, but there is usually little to no advice beyond your investment portfolio. Many major financial decisions, like buying a house, getting the right insurance, estate planning, etc., are mostly outside of the purview of a robo-advisor.
- Investments are static: Robo-advisor portfolios almost always have static portfolio targets. While the portfolio is automatically rebalanced back to those targets, the targets themselves do not change. However, the world economy is constantly evolving, with risks and opportunities changing over time. You may want a portfolio that evolves with an ever changing world. Most robo-advisor portfolios lack this dynamism.
- Lack of advanced tax strategy: Smart tax decisions can help you keep more of what you earn in your investment portfolio. This becomes especially important as you approach retirement, consider executing employer stock options, or plan your estate. Robo-advisors generally offer limited tax-advice, and the advice they do give is often very general, not tailored to your situation.
- Tax-loss harvesting: Tax-loss harvesting is a good strategy, and can add value to your portfolio if executed right. However, be careful overrating its benefits. Tax-loss harvesting is something most individual investors don’t execute well on their own. However, most kinds of financial advisors offer this service. The benefits to tax-loss harvesting are sometimes pushed hard by robo-advisors, but robo-advisors aren’t necessarily in a better position to realize the benefits of tax-loss harvesting than other advisors. This is particularly true of tech-forward financial advisors like Facet.
- Potential for conflicts of interest: When considering any financial advisor, you need to take into account the potential for conflicts of interest. Just because robo-advisors use algorithms to give investment advice doesn’t eliminate the risk of conflicts. There have been significant SEC fines over conflicts related to robo-advisors in the past.
- No human advisors: Perhaps the most obvious disadvantage of robo-advisors is the most important: a lack of humans. An experienced human advisor can help by talking over a major life event, discussing potential changes to your financial plan, or just answering questions about market events. Robo-advisors generally don’t have people to field these kinds of questions, whereas comprehensive financial planning firms do.
Robo-advisor vs. comprehensive financial planner
While individual services may vary, here is a high-level look at how a typical robo-advisor generally compares to a comprehensive financial planning firm like Facet.
| Robo-advisor | Comprehensive financial planner | |
|---|---|---|
| Portfolio construction | Yes | Yes |
| Regular rebalancing | Yes | Yes |
| Tax-loss harvesting | Yes | Yes |
| Fiduciary duty/standard | Yes, typically are Registered Investment Advisors | Yes, most, including Facet, are Registered Investment Advisors |
| Dynamic investment management | No | Varies, Facet includes dynamic investment management |
| Cash management | Yes, usually offer high-interest cash options | Varies, Facet offers high-yield cash management |
| Account minimums | Usually very low, often <$100 | Varies, Facet does not require investment accounts at all |
| Financial planning | Limited, mostly just used to determine asset allocation | Varies, but generally much more comprehensive than robos |
| Tax strategy | Limited | Varies, Facet provides tax strategy, with tax filing available through our partners at certain membership tiers* |
| Fees | Usually based on asset level, around 0.25% is common | Usually based on asset level, with 1.00% being common, although some firms like Facet charge a flat fee |
| Available human advisors | Limited to none | Varies, but usually have a dedicated team or individual working with you |
*Facet is not a CPA firm and does not prepare or file tax returns. Tax preparation and filing services are provided through Facet’s designated tax filing partner and are available to eligible members in the Plus and Complete tiers. Partner terms and conditions may apply.
Is a robo-advisor right for me?
A robo-advisor may be a good fit if you are just starting out investing and the rest of your financial life is relatively simple. As your financial life gets more complex, it may be more beneficial to utilize a comprehensive financial planner.
With robo-advisors, there is an element of “you get what you pay for.” They don’t offer much outside of basic investment and portfolio maintenance services. However, you may also not have a need for the more advanced financial planning and/or tax advice that more comprehensive advisors offer. If that is the case, a robo-advisor may very well be your most cost-effective way to get help with your investments.
However, if any of the following are true, it might be at least worth considering a more comprehensive financial planning service like Facet.
- Own a home or are considering buying a house: This is one of the biggest financial decisions most people will make. A planner may be able to help think through how much you can afford, give advice on getting a mortgage, and how owning a home could impact the rest of your finances.
- Have children or plan to soon: Having kids creates all kinds of financial issues: insurance, education saving, estate plan, etc. Robo-advisors generally don’t cover these issues in any depth.
- Earn any kind of equity-based compensation: If you own stock options, restricted stock units (RSUs) or any other kind of equity in your employer, it can complicate your financial and tax picture. These need to be handled carefully, otherwise it can increase the risk to your retirement plan and/or cost you in taxes. You want a real expert to help with a plan around stock options and RSUs.
- Are close to retirement: The closer you are to retirement, the more complex and more personal your financial plan becomes. You will need to come up with a strategy for portfolio withdrawals, while managing the risk of running out of money. Some investment portfolio risks change in retirement and/or become more problematic. There are also more tax pitfalls, especially around retirement account distributions. You might want to employ Roth conversions or other more advanced tax strategies. You may care more about enjoying your retirement, or be more focused on leaving a legacy to your heirs. The right retirement plan is very specific to you and your specific circumstances. A robo-advisor isn’t going to know you or your situation well enough to create a retirement plan that covers all of this personalized advice.
- Have a larger investment balance: With smaller balances, say under $50,000, more advanced investment or tax strategies may not matter much to you. But as your assets grow, you might get more value from a more sophisticated investment plan. Note that as your investments grow, so does the robo-advisor’s fee. This isn’t an issue with a flat-fee financial planning firm like Facet.
So whether a robo-advisor is right for you depends on where you are in your financial life and what kind of advice you want or need. For some people, a robo-advisor can be a great option. For others, robo-advisors just don’t offer the depth of advice that they need.
