Choosing a Robo-Advisor in 2020: Tips You Need to Know

How to Choose Between Robo-Advisors

Choosing a robo-advisor is no small feat. Where do you start? What do you look for? Keep reading below and you’ll learn everything you need to choose the best robo-advisor for your financial goals — whatever they may be.

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These days, robotic devices are becoming more and more a part of our everyday lives.

Information echoes through our ears at the drop of a “Hey, Siri!”, while mundane tasks like setting a timer for the heating to come on are slowly but surely disappearing from our daily schedule of mundanities.

This past decade has seen the growth of “robot” assistants helping make financial decisions, but few would’ve guessed that they would quickly become such an important player in our tech evolution.

Astoundingly, a recent study has shown that robot analysts outperform humans when it comes to choosing better stocks. Does this mean that bots are the only way forward? Will financial advisors soon be out of a job?

Before you make up your mind about whether or not a robo-advisor is the best choice for you, we’re going to take you through the growth of the automated investment industry, and why they have become such a strong force in society, as well as highlighting the importance of the human element within this structure.

So, how should you choose a robo-advisor? Which criteria are the most important to consider? Are free robo-advisors the way to go?

In this guide, we’ll discuss the all important fees, and break down the pros and cons for both robo-advisors and human advisors before dissecting what that means for you, your personal situation, and financial goals.

Robo-advisors’ ability to implement automated tasks is first on the list.

Robo-advisors facilitate automated investment strategies without the need for human advice.
With robo-advisors, investments become automated through smart algorithms.

Automated Investments

Robo-advisors have completely changed the investing narrative by bringing services straight to the consumer.

Although robo-advisors started off performing simpler and more straightforward tasks, they have now evolved to handle more complex ones such as tax-loss harvesting, retirement planning, and investment selection.

For this reason, the robo-advisory industry has gained immense growth since its beginning, and by 2025 the industry is projected to hit $7 trillion worldwide.

Automated investments are probably the single biggest factor associated with robo-advisors. Investment strategies utilized by robo-advisors are based on both the Efficient Market Hypothesis, and Modern Portfolio Theory (MPT). But what exactly are these?

Modern Portfolio Theory suggests ways in which investors who want to minimize risk can construct portfolios in a way that should result in the highest possible expected return based on the current market risk, highlighting that greater risk, as scary as it is, is a necessary component of earning greater returns.

In this Theory Harry Markowitz argues, creating an efficient frontier” of portfolios optimal portfolios that offer the highest expected return possible can be done for any given level of risk

The Efficient Market Hypothesis (EMH) states that share prices are a reflection of the information as a whole and that consistent alpha generation is not possible. According to the EMH, stocks are always valued fairly on exchanges, and it is not possible to buy undervalued stocks or sell them at higher prices. Therefore, attempting to outperform the market overall through expert stock selection or market timing is impossible, and the only means to gain greater returns is through riskier investments.

Both this theory and hypothesis are configured to determine the best way to invest on your behalf.

To do this, first, you’ll take a survey where you’ll be asked information about your investments, experience, tolerance to risk, and financial goals, and once your robo-advisor analyses the information you’ll be offered a portfolio and asset allocation that is appropriate and suitable for the information given.

Of course, you can make adjustments to the portfolio if you’re not happy with it, but on the whole you invest your money, taking into consideration the minimum account requirements, and the robo-advisor will do all the nitty-gritty, hands-on stuff for you ie. it will invest your crisp money on your behalf.

This means that you can avoid all the complex, head-sore investment decisions, the back-and-forths between ideas, and the myriad of factors that often need to be taken into consideration before you invest.

If you’re just starting, you might not have the knowledge or experience necessary when investing in exchange-traded funds or mutual funds to make the most informed decision; Robo-advisors take care of all the decisions, using the methods mentioned, to create a portfolio that meets your needs and goals.

To clarify, this means that robo-advisors offer a service, but not guidance. Are robo-advisors a good idea? Well, there are plenty of investors who say yes. Others prefer a guided approach to investing. And that’s where the real difference lies between robo-advisors and financial advisors.

Want to see how the top robo-advisors compare? Check out out our reviews of the best robo-advisors available today..

Management Fees

Robo-advisors offer lower fees than traditional financial advisors. They make money by charging an annual management fee based on your invested assets, and charged as a percentage of these. For example, if the fee is 0.25%, you will be charged $40 on a $20,000 account balance.

Online advisor management fees begin at zero – we’re looking at you, Charles Schwab Intelligent Portfolios – although 0.25% to 0.50% is a more typical window. That’s right — there are free robo-advisors.

Certain advisors, including Wealthfront and SigFig, will manage certain assets for free. These advisors are great options for traders with smaller investment amounts. With that, account closing fees are generally not charged by robo-advisors so, if you change your mind or find that robo-advisors are not for you, it won’t cost you a cent to move when you have enough to open an account with another provider.

If you’re looking for free robo-advisors, there could be a couple of options depending on how much you plan to invest.

How does a Robo-Advisor Work?

Although robo-advisors charge less fees, choosing a robo-advisor should take into account more than just fees, which account for just one part of the equation. Another significant piece of information to be considered are the services provided by a robo-advisor. Robo-advisor services could potentially increase your returns and put you on the right track to meet your goals.

Standard robo-advisor services are made up of tax-loss harvesting, portfolio allocation, and perhaps most beneficial of all, automatic rebalancing. Most interestingly, different advisors offer their own specific, and sometimes unique services, that are of particular benefit to some.

For example, Personal Capital offers a Retirement Planner feature that helps you check whether your retirement plan is on course. The firm also offers a Retirement Paycheck that guides you on the best way to take out your retirement savings to save on tax.

Wealthfront offers direct indexing on account with $100,000 and over. This allows for a bigger tax advantage when investing individual securities.

Investment Options

It must be acknowledged that robo-advisors are still very much in the early stage of their rise, and many have noted this. Their existence almost exclusively within a bull market suggests that any outperformance of one advisor over the other could be due to the asset classes the advisor is leaning on more, as opposed to any long-term statistics of success. Investment options are also simply just another singular part of the equation.

So when it comes to the question of ‘how should you choose a robo-advisor?’ — investment options are a primary consideration. You can review these by looking at the expense ratios of the investments.

Expense ratio fees are charged by the investment fund companies not the robo-advisor, though arguably, it doesn’t matter who is charging the fees, they are fees none-the-less.

For instance, firms that hold proprietary funds – such as Charles Schwab, Fidelity or Vanguard, will usually be included in the portfolios created by their robo-advisor. Your goal: choose an advisor that keeps expense ratio fees to the absolute minimum.

In most cases, robo-advisors invest in exchange-traded funds only. The number of asset classes included in the portfolios should be considered. This information, along with the fees should be laid out clearly on the advisors website, or during your initial call with an advisor.

If ETFs aren’t your thing, or you’re not comfortable investing in them for whatever reason, look out for online advisors that offer more personalized portfolios, such as Vanguard’s Personal Advisor Services, or Personal Capital services for very high-net-worth clients.

Robo-advisors have both pros and cons when compared to human financial advisors.
Account minimums are a crucial factor when considering how to choose a robo-advisor.

Account Minimums: Starting From $0 Got Nothing to Lose

“You offer more inclusivity to trading”

“I want to earn some high returns”

“Maybe we can build a portfolio?”

“Maybe together we can hit financial goals?”

“Minimum balance requirements sure would help”

“Starting from zero got nothing to lose”

The minimum account deposit required can start at $0, it can also soar as high as $100,000. And this my friends, will be another key component of choosing a robo-advisor.

Ideally, new investors should pick an advisor with a $0 account minimum. However, zero might not always be the best option, and $0 requirement for account balances won’t necessarily yield you the best returns.

If you have dollars to spare, and/or would benefit from more personalized advice and guidance, then you will probably also need to make a higher initial minimum investment. Nonetheless, account minimums are crucial to be aware of when considering how to choose a robo-advisor.

The available account types should be your next consideration, especially if you want a guaranteed return on your investments.

Account Types Offered

In most cases, online advisors cater to two account types. Individual retirement accounts (IRAs) and taxable accounts specifically. Some also manage trusts, and less manage in 401(k)s, Blooom is one.

401(k) accounts that match dollars should be high on your list of things to take into consideration when choosing a robo-advisor because accounts that match dollars are a guaranteed return on your investment.

High-net-worth clients, or those who’ve maxed out a 401(k) account should consider taxable accounts and IRA contributions for long-term savings, like retirement.

You may also come across advisors with their own niche accounts, like solo 401(k)s or business accounts. Ally Invest Advisors and TD Ameritrade Essential Portfolios are both exceptional in this field.

The next thing to highlight is something we touched on earlier. That is, robo-advisors provide a service, and not financial planning or guidance.

No Guidance Offered (Except for the Exceptions)

Make sure to factor into your choice that robo-advisors do not offer guidance, they offer a service. While investment management and financial planning are both important depending on your individual needs, they are not one in the same.

For financial planning, you will have the guidance of a financial advisor. Clients will have a dedicated advisor offering individual support, and accountability.

The journey to financial success is a long one filled with ups, downs, distractions, and misunderstandings – and financial planners can help make this process a little more clear and straightforward. Robo-advisors on the other hand offer solutions and choices, but with less context and explanations.

The automated process still requires you to avoid making some rookie mistakes like;

  • Not contributing towards your investments
  • Failing to gradually increase your contributions
  • The classic: Selling low and buying high
  • Making decisions based on emotion or irrationality (like investing in companies in your home country out of bias, as opposed to informed reasoning)

Think of financial advisory services like this: you can pay for a course, and reap the benefits of the course material, but along the way you might need additional advice from your tutor. This advice will help the student understand and carry out their assignments to the fullest, in addition to meeting the deadlines necessary for grading.

As a result of the guidance, the student receives higher grades, and can more confidently implement what they’ve learned when in the workplace.

Similarly, financial planners can help you make more informed, and confident investing decisions, and hold you accountable to your goals.

The exception to this is the hybrid robo-advisors that offer both robo-advisory services and human elements to provide the best of both worlds.

The Age-Old Question: Robot Vs Human

Hybrid robo-advisory services also provide real live humans, be it through a team of financial advisors or a dedicated financial advisor that offers a personalized service. The latter will cost more, because human time is worth more.

Examples of this include digital asset management service, Personal Capital, Face Wealth, Charles Schwab Intelligent Advisory, Vanguard Personal Advisor Services, and Betterment.

Robo-advisors that also offer financial advisor services will cost more. Personal Capital, for example, charges 0.895 and offers those with $200,000 or more a dedicated financial advisor. Clients that don’t meet this minimum receive access to a team of advisors.

Don’t be fooled. Take note of the credentials the financial advisors have because they can vary greatly – some are registered investment advisors while others are the ideal, fully-fledged, certified financial planners.

Figure out how much access you’ll have to the advisors, too. Some providers offer limitless access while others only offer a set amount of support. Personal Capital offers unlimited access to those with high account balances, but not to others. Betterment has a similar offering.

Read here for more on the robo-advisor vs human financial advisor debate.

The Pros & Cons of Choosing a Robo-Advisor

Robo-advisors are very beneficial for investors with particular needs. Using a robo-advisor ensures a low-cost solution for those with lower budgets or newer investors looking to start out smaller. Less costs gives the advantage of more money to invest and potentially more returns.

While the fee for a robo-advisor is less than a financial advisor, this is because of some very distinct differences between what they can both offer. Robo-advisors don’t have the ability to incorporate long-term life goals into the equation, and therefore any investment strategy offered up fails to recognize other factors that may through it completely off course.

At the basic level, fees are lower because robo-advisors typically invest in ETFs and index funds. But there are some who offer a better range than this, and if you’re up for investing in these yourself then you could easily skip past the Robo part completely.

Typical ETFs use solutions like Vanguard’s funds and ETFs, which are publicly available without needing to sign up to a provider or pay any robo-advisor fees, something which is an additional fee on top of the existing ETF or mutual fund fee. As a whole, it is wise to look at the automated rebalancing and tax-loss harvesting that robo-advisors offer.

Considering signing up to a provider can require a hefty initial deposit. To sign up with Vanguard for example, you will need a minimum of a few thousand dollars.

Robo-advisors on the other hand, often don’t have a minimum balance requirement to start investing. This makes it the more accessible choice for younger investors to enter the arena earlier on – and time is of the essence when it comes to compounding interest and building a bank of wealth.

Signing up to a robo-advisor generally takes less than 10 minutes. It’s quick and easy to do. Those interested simply create an account by entering a username and password, and filling out a short questionnaire. It is one of the simplest options out there. From there, you can go ahead and start creating various investment accounts and automating deposits.

Lest We Not Forget: Other Considerations When Choosing a Robo-Advisor

Don’t forget, if you have any questions, queries, thoughts or hesitations, you can arrange a call with a financial advisor to talk to through everything, or point you in the right direction.

A robo-advisor won’t offer you that same support, although basic customer support lines are offered in most cases. This won’t be the same as having a dedicated advisor, and they won’t be particularly familiar with you or your situation.

On that same note, a financial advisor has a lot to offer that a robo simply isn’t built to, yet.

We’re all prone to making decisions based on emotion or bias. The panic that sets it during a downturn or the urge to chase underperforming stocks is inherent within us all, and almost impossible – if not impossible – to overcome. A financial advisor can help keep your decisions on track by offering an outside expert look at situations and offering more objective advice.

Robo-Advisors offer a low-cost accessible platform, while human-advisors offer the more human elements like advice and accountability.

Robo-advisors are simple and straightforward, but this might not be what you need. Particular life goals can’t always be covered over short questionnaires.

While robo-advisors remove the complicated decision making stage, it also eradicates the necessary context and subtle nuances. That is, robo-advisers choose portfolios for completely different, (albeit logical) reasons than investors.

When are Robo-Advisors a Good Idea? 

Robo-advisors are the best option for young investors, those with simpler goals, and those starting out with lower budgets, due to the low-fees associated with them.

Anyone with less than about $25,000 should consider working with a robo-advisor to give you a head-start with building your wealth because you won’t have to pay more than you need to. How you should choose a robo-advisor however, first and foremost depends on your specific needs.

Anyone with more complex needs or goals, however, will benefit greatly from the advice and experience of the professionals.

Financial advisors provide that individual care and solutions, as well as offering alternative, and perhaps more suitable investment options that are not available on robo-platforms.

Human advisors can help you grow your funds beyond ETFs and index funds, and can help you minimize risk and adapt to the changing environment that robo-advisors just can’t offer yet.

Anyone starting out and looking to gain build on their current funds would do well with a robo-advisor. Financial advisors will help take care of the more complex aspects after this by offering more experience, accountability and options, to name a few.

About Author

Tim Fries Tim Fries is the cofounder of The Tokenist. He has a B. Sc. in Mechanical Engineering from the University of Michigan, and an MBA from the University of Chicago Booth School of Business. Tim is also the co-founder of Protective Technologies Capital (protechcap.com).