Robo advisors are a relatively new technology, and the safety of their services is still an open question. On the one hand, they can provide diverse investment portfolios to inexperienced investors who often lack the time and resources to construct their own.
On the other hand, algorithms used by robo-advisors may not consider important factors that could shape decisions outside of analyzed data.
A Robo Advisor is simply a traditional investment advisory firm that has automated the process of providing advice and portfolio management services to customers. It would be best if you did not assume all Robo Advisors are a safe investment, and the financial services industry is prone to scandals and fraud. So, to answer the question, are Robo Advisors safe? You have to ask three questions.
5 Steps to Check if a Robo-advisor is Safe?
A robo-advisor is simply a traditional investment advisory firm that has automated the process of providing advice and portfolio management services to customers. It would be best if you did not assume all Robo Advisors are a safe investment, and the financial services industry is prone to scandals and fraud. So, to answer the question, are Robo Advisors safe? You have to ask three questions.
1. Are your assets safe and regulated?
The total Assets Under Management in the robo-advisory market are projected to reach $3 trillion in 2023. It is important to note that this figure represents a global estimate. Like all investment advisors, Robo Advisors must be registered as brokers/dealers and comply with all applicable regulations by being FINRA and SIPC members.
You should check the background of any investment firm you are planning to use by performing a search on the firm online @ FINRA.
Of course, any broker you use should also be a Securities Investor Protection Corporation (SIPC) member. This nonprofit organization will protect your investments up to a maximum of $500,000 ($250,000 in cash).
As the Robo Advisory industry grows very quickly, there are issues with transparency and marketing of the services. The SEC has laid out advice for investors to help them navigate the process of evaluating and selecting good service providers.
2. Are the automated processes (algorithms) used to select your portfolio safe?
You must evaluate some areas of performance, including security and transparency. Strangely, transparency is one of the most important areas of Robo Advisor performance, but many people ignore it. Transparency means the advisor lists all features, capabilities, and strategies.
For example, the manager lists all the equities in a portfolio and explains every strategy used. Management should tell you when they make a change or add a feature. In addition, they should provide clear explanations and justifications for any feature in plain English.
Hence, avoiding a Robo Advisor with low transparency would be best. If you do not have a rudimentary grasp of what is going on, you should avoid a robo advisor.
There have been two high-profile SEC cases involving Robo Advisors. The biggest settlement was in 2018 against Wealthfront Advisors, who were fined $250,000 for misleading investors about the tax-loss harvesting services they would receive. They failed to provide the tax-loss harvesting service they marketed as standard to 69% of their customers over three years.
3. Are the online systems used by Robo Advisors Secure?
Finally, transparency is doubly important for security. For instance, an advisor should tell you about any security breach immediately. They should warn you so you can change accounts and passwords before crooks get into your other accounts.
The advisor must clearly explain all security features and protocols. Moreover, security features should work quickly. For instance, there should be an easy but secure way to access your account if you lose your password. An example of such backup access is an algorithm that sends a text to an encrypted phone if you change your password. They usually call such features as 2-step authentication.
Plus, the advisor should list all the security protocols and features and explain them. If an advisor does not provide a clear security picture, you should avoid it.
The bottom line is that a Robo Advisor that does a poor job of security and transparency will cost you money. Thus, avoid any Robo Advisor that is lacking in either security or transparency.
4. Where is the Robo-advisor Located?
Is a robo-advisor is located in an offshore location like the Cayman Islands or Panama, then it is wise to stay away from them. These areas are known for their lack of financial regulations and may not offer adequate protection against fraud or other risks.
It is important to make sure that your robo-advisor is located in a jurisdiction with clear laws and regulations governing the industry. Locations such as the United States, Canada, and the European Union are known for having reliable laws and regulations in place to protect investors.
5. What Are the Fees?
Robo-advisors charge fees for their services, just like any other financial adviser does. Before signing up with a Robo Advisor, make sure you understand what fees apply and calculate how much they will cost you over time.
It’s also important to make sure you’re getting a fair price for the services being offered. Shop around and compare fees from different Robo-advisors so that you can find the one that best suits your needs in terms of cost.
Finally, it’s important to remember that some robo-advisors may offer free or discounted services for certain types of accounts or investments. Make sure to do your research and find out if there are any offers or discounts that could save you money.
The Bottom Line
Robo-advisors can be a great way to access professional advice for a fraction of the cost of traditional financial advisors, while still enjoying all the benefits associated with investing in the stock market. They offer low fees, comprehensive management services, and easy access to a wide range of investment options. However, it’s important to understand the fees associated with each advisor before signing up for an account
Make sure to shop around and compare fees from different Robo-advisors so that you can find the one that best suits your needs in terms of cost, while still ensuring that you’re getting a quality service. Additionally, keep an eye out for any offers or discounts that could save you money and make sure to read all the fine print before signing up.
Taking the time to understand what each Robo-advisor can offer will help you find the best fit for your individual needs.
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