Why Robo Advisors are Better Than Financial Advisors
Many people rely on their personal financial advisor to invest their money. However, research has shown that the returns of professional investors do not beat the returns of the average market. Also, they charge fees that again reduce the return. A different set of people believes in investing on their own and do the respective research to do so. There are many more people who are not sure about investing by themselves but also do not want to spend great amounts on fees for financial advisors. As financial advisors usually require a certain minimum fee, many people do not get into a position to be able to get advice. Robo advisors might be a solution for everybody who is not sure about investing on his own but also is afraid of high costs of financial advisors or people who do not have access to those
“When trillions of dollars are managed by Wall Streeters charging high fees, it will usually be the managers who reap outsized profits, not the clients.”
Warren Buffett, American investor, CEO of Berkshire Hathaway, considered one of the most successful investors in the world
Robo-advisors are a good start for beginners and people with small investment amounts
Robo-advisors create investment strategies and manage your investment automatically. They allow investing amounts based on the specific requirements of the user – also for small amounts – meanwhile not generating excess costs. Most robo-advisors focus on portfolio management. This means robo-advisors do not consider real estate or retirement planning. A financial advisor sees a more holistic picture of the client and provides overall advice. Robo-advisors usually offer
- Asset allocation based on the identification of preferences and risk affinity
- Automatic portfolio rebalancing
- Tax optimization strategies
“The biggest thing robo-advisors are doing is giving help to people who never had help before”
Chris Costello, CEO of the robo-advisor Blooom
Robo-advisors usually invest in ETFs
Robo-advisors usually invest in ETFs. ETFs replicate share or bond indices, e.g. the DOW Jones or S&P 500 at very low cost. An ETF does not try to be smarter and better than the broad masses of investors by targeting individual stocks. With an ETF you follow the majority and you can participate in the market easily and cheaply.
“Both large and small investors should stick with low-cost index funds.”
Warren Buffett, 2016
Robo-advisors save costs
Financial advisors earn their salary through fixed consultancy fees or commissions. In the latter case, financial advisors are likely to suggest products with higher commissions. A financial advisor that works fee-based will only be interested if there is a minimum revenue that he can generate, usually around $5,000 annually. He will charge this as a direct fee, as a percentage of the overall value of the portfolio (usually around 1%) or by the hour.
Robo-advisors usually charge less than 1% of the money under management per year. Costs vary by provider and can be differentiated into:
- Management fees: usually 0.25% to 0.5% of the money under management per year.
- Funds’ expense ratios: usually 0.05% to 0.65% per year.
- Incidental fees: usually no set-up costs are charged, look for a good provider
Robo-advisors guide you through the process
Robo-advisors create a suggestion for your asset allocation based on an assessment that you complete online. The robo-advisor adjusts your investments automatically on an ongoing basis. Your choice concerning the investment is limited as robo-advisors mostly invest in ETFs. This is good for beginners and smaller portfolios. Bigger portfolios can be managed more actively as factors like taxes have to be taken into consideration more thoroughly.
Robo-advisors have limitations
Robo-advisors only cover a certain area of possible investment products. More personal possibilities such as company benefit programs and tax-favored solutions (e.g. 401(k) in the US) are not regarded. A personal financial advisor might have more specific advice. In conclusion:
- Robo-advisors are a low-cost solution for beginning investors with small asset under management.
- Robo-advisors provide services at low-cost.
- Robo-advisors do not provide integral financial planning.
- Robo-advisors do not protect from market fluctuations as they invest mostly in ETFs. You still need to stay cool at a market low.
Four golden rules to choose a Robo-advisor
To find the right robo-advisor for you, you should take into consideration different criteria.
- Understand fees involved: The most important fees are management fees for the robo-advisor company and the funds’ expense ratios that go directly to the company that manages the ETFs.
- Minimum Investments: Some robo-advisors have a minimum investment.
- Promo Offers: Robo-advisors are free up to a certain amount and some have promotion offers.
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