Investing is a key part of building wealth over the long run, but constructing and maintaining an investment portfolio can be difficult. To properly diversify, you should own dozens of different securities, but managing a portfolio like that can lead to a lot of headaches.
What is a Robo Advisor?
A robo-advisor is a specialized computer program that helps investors construct and manage their investment portfolios. To start using a robo-advisor, you usually have to fill out a survey, giving it information such as your age, income, debts, financial situation, risk tolerance, and future goals. The robo-advisor sends your data through an algorithm that produces a portfolio to help you achieve those goals. While removing the human element might seem scary, it also drives down costs. Robo-advisors operate under the assumption that the people who use them will most likely adopt a buy-and-hold strategy and that asset allocation is the main determinant of a portfolio’s performance.
Robo-Advisor vs. Mutual Fund: Key Differences
Many investors turn to robo-advisors and mutual funds for help with managing their investments. To decide which is right for you, it’s important to understand the key differences between them.
- Fees- A traditional advisor charges a management fee of 1-2% per year. In addition, they may recommend mutual funds or other investments that carry additional high fees and eat away at your profits. Robo-advisors, however, charge fees of about 0.25% annually. This lower cost means you get to keep more of your investment earnings.
- Investment Strategies- Mutual funds can have a wide variety of investment strategies. Investors can examine different mutual funds and try to find one that aligns with their specific investment goals. Robo-advisors can adjust their investment strategy to the needs of each investor, building a portfolio that aligns with that investor’s goals
● Personalization- A major advantage that robo-advisors have over mutual funds is personalization. When investing in mutual funds, you can only look at the selection of funds available, consider their investment strategies, and invest in the one that aligns most closely with your goals. You can’t make customizations to their strategies.
● Lack of transparency- Financial advisors sometimes get a bad rap for not explaining to their clients what their investments are or how they work. Sometimes, trying to explain a complicated product to someone with minimal knowledge, can be difficult and time-consuming, which is why robo-advisors keep it pretty simple.
Robo-Advisor: Advantages and Disadvantages
Robo-advisors offer significant benefits to investors, but you need to consider the drawbacks before you sign up.
- Hands-off investing
- May be cheaper than working with a human advisor
- Fees can build up
- Lack of human involvement in decisions
Who is most suited to use a Robo-Advisor?
Robo-advisors are typically best for people who want to be as hands-off with their investing as possible and who have sufficient assets to benefit from services like tax-loss harvesting. Very high-net-worth individuals (HNWIs) with complex estate or tax situations, or those with very small balances, may not get the full benefits that robo-advisors can offer.
Robo-Advisor vs. Mutual Fund: Which is Best?
Mutual funds and robo-advisors can both be a good way to invest, so you’ll have to think carefully to decide on which to use. On one hand, if you want the most hands-off way to invest, then a robo-advisor is the way to go. It will build and manage your portfolio entirely on its own. If you want to use mutual funds, investing is relatively easy, but you do have to put in the effort to find the right funds to invest in. The best robo-advisors also offer some additional benefits and services. A popular offering is tax-loss harvesting, which they argue can increase your returns, often by enough to more than cover the fees that they charge.
Robo-advisors and mutual funds are two options for investors who want to avoid the day-to-day aspects of managing their portfolios. Mutual funds offer the benefit of professional portfolio management, but you’ll have to put in the effort to find the right fund for your needs while robo-advisors offer personalized portfolios and services like tax-loss harvesting.