Are Robo Advisors A Good Idea?
Robo Advisors are a good idea if you want to have the following benefits:
- Many Robo Advisors are tuned for optimal tax loss harvesting – saving you money
- Robo Advisors are tuned for automatic portfolio rotation & adjustment – saving you time
- Automatic balancing of a portfolio based on your risk profile – reducing your risk
- Provision of low-cost access to ETF’s & Mutual Funds – reducing trading costs
- Some Robo Advisors provide model portfolios for socially responsible investing
- Robo Advisors allow for gender or life-stage specific portfolios – providing a personalized portfolio
- All Robo Advisors provide instant access to your investment performance – transparency
- Hybrid Robo Advisors allow you to talk to a human account manager – the human touch
1. Many Robo Advisors are tuned for optimal tax loss harvesting – saving you money
Some but not all Robo Advisors incorporate tax loss harvesting into their automated portfolio management. If you have done any private investing before, you will know that the end of year tax planning on your investments can be a significant burden. You are compelled to sell any losing stocks you may have to be able to offset your taxes against the loss.
As Robo Advisors are usually highly automated they can run the relevant algorithms to optimally offset elements of your portfolio to minimize your tax burden for the year.
A good Robo Advisor service like M1Finance will deliver the following documents after the year-end, usually in January:
- Tax Form 1099-R
- Tax For Consolidated 1099
- Tax Form 5498
2. Robo Advisors are tuned for automatic portfolio rotation & adjustment – saving you time
Nearly all Robo Advisors are based on the principle of Modern Portfolio Theory (MPT) which is a widely utilized methodology for assigning a weighting to different types of financial assets to achieve the optimal balance of risk versus reward.
Employing MPT allows the Robo Advisor service to automatically adjust your weighting in different assets, like stocks, bonds, currencies, but mostly ETF’s, to try to assure an appropriately diversified portfolio.
The process is designed to offset risk through diversification, but one of the problems with that approach is it can also offset a lot of reward, as most Robo Advisory services do fail to beat the underlying market index, usually the S&P500 index.
3. Automatic balancing of a portfolio based on your risk profile – reducing your risk
For example, you may be close to retirement and decide that you want to minimize your risk of loss in the event of a stock market crash. In this case, you would want to perhaps have 80% of your portfolio in bonds and 20% in stocks and ETF’s.
Robo Advisors will automatically perform the readjustment of your portfolio based on your risk profile. Some allow you to select the weighting of assets, but others offering even greater levels of simplicity will simply let you answer a few questions and make the adjustments for you.
4. Provision of low-cost access to ETF’s & Mutual Funds – reducing trading costs
Most Robo Advisors will simply buy and sell Exchange Traded Funds (ETF) on your behalf. here you need to be careful, as not all robo advisors are created equally. Not all are low cost and many, especially the bigger names like Vanguard, Schwab, and Fidelity may charge a management fee and also fill your portfolio with the ETF’s they manage and charge an additional ETF fee on top.
[Related Article: Find out more about the fees and costs associated in Our Robo Advisor Comparison]
As a person who eats organic food, is practically vegetarian, and really cares about the environment and the social impact of capitalism, I find a key benefit of the Robo services are socially responsible investing portfolios. Companies such as Ellevest, Betterment and TD Ameritrade enable you to bypass the burden of doing your own research into the background of every company you invest in by offering pre-structured socially responsible portfolios.
Other companies such as M1 Finance go even further by providing hundreds of different model portfolios (they call Pies) so that you can mix and match your portfolio based on a collection of pies.
6. Robo Advisors allow for gender or life-stage specific portfolios
In a world unfortunately still dominated by men, Ellevest seeks to breath fresh air into the stuffy male-dominated investment industry. The unique selling point and the niche market that Ellevest have carved out is by focusing on the unique needs of women. Interestingly women live longer than men, usually have a career break for children and earn less than men, this means that women require different advice more suited to their life events.
7. All Robo Advisors provide instant access to your investment performance
Of course, this is something you would expect, the transparency of seeing how your portfolio is balanced and the return on investment you are getting is paramount.
M1 Finance allows you to get a very good insight into how your portfolio is balanced and what assets your own.
8. Hybrid Advisors allow you to talk to a human account manager
A Hybrid Robo Advisor service is essentially the addition of some traditional customer service to the mix. This means you will have telephone access to a registered financial advisor to be able to talk through your situation, preferences, and questions.
Of course, this higher level of personalized service usually comes with additional fees. Betterment, Ellevest, Morgan Stanley, TD Ameritrade, Vanguard and Fidelity all offer this type of service. See our Robo Advisor comparison for more granular details.
Are Robo Advisors A Good Idea?
As you can see, a Robo Advisor is a very good idea because you can save time in managing your tax loss harvesting, ETF and asset selection and automatically reinvest towards your retirement. You can also save money because often Robo Advisory will optimize your tax loss harvesting and minimize your trading costs.
The downside is that most Robo Investment services fail to beat the market, meaning they do not provide higher returns than simply investing in a single market indexed ETF e.g. the S&P500 index. Many claim that beating the market is not important and that minimizing risk is the most important, you can decide for yourself what is most important.
Let us know your thoughts in the comments section below.