February 2, 2023

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Should You Use One? Pros and cons (+tips)

You may have heard of “robo-advisors” like Betterment and Wealthfront. Robo-advisors are investment firms that use computer algorithms to invest your money (“robo” refers to a computer that invests for you, as opposed to an expensive advisor).

You’re probably wondering if they’re a good investment and if you should use one. As the NYT best-selling author on personal finance, let me break it down for you.

NOTE: If you are looking for more information about investing, I recommend reading these other articles I have written:

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Robo-advisors took the elite financial planning services offered to clients by financial advisors and full-service investment firms like Fidelity and made them accessible to the average person.

You know how Uber made private cars more accessible and convenient than taxis? That’s pretty much what robo-advisors have done to the investment industry.

Robo-advisors implemented new technology to offer investment recommendations at low fees. They’ve improved the interface so you can sign up online, answer a few questions, and know exactly where to put your money in minutes.

And they’ve personalized the experience so you can add your goals – like buying a home, for example – and automatically set aside money for them.

Are robo advisors a good investment?

I have strong opinions about robo-advisors:

While they’re good options, I don’t think they’re worth the cost and I believe there are better options.

As an example, I specifically chose Vanguard and have been with them for many years.

Let me explain the pros and cons of robo advisors so you can make your own decision.

Pros and cons of robo advisors

Benefits of using a robo advisor

In recent years, robo advisors have grown in popularity for three reasons:

■ Ease of use. They have beautiful interfaces on the web and on your phone. They offer low minimums and make it easy to transfer your money and start investing.

■ Low fees. In general, their fees started out lower than those of full-fledged investment firms like Fidelity and Schwab. (These companies were quick to spot their competition and lower their fees accordingly, while low-cost companies like Vanguard have always had low fees.)

■ Marketing claims. Robo advisors make many marketing claims. Some are true, like their ease of use. Some are disingenuous, bordering on the absurd, such as their focus on “lost tax revenue.”

As you’ve probably noticed if you’ve read any of my other personal finance blog content, I’m a huge proponent of anything that extends the use of low-cost investing to ordinary people.

Investing for the long term is a crucial part of living richly. So if companies can remove the complexity and make it easy to get started – and even charge a generally low fee – I’m a fan.

These robo-advisors have added phenomenal features that are really helpful, including planning for medium-term goals like buying a home and long-term goals like retirement.

Also, you often realize how good something is when you hate it.

For example, Bank of America hates me for calling them publicly about their bullshit. Well! In the case of robo-advisors, commission-based financial advisors generally hate them because they use technology to do what many advisors were doing — but cheaper.

The logic of the consultants is not particularly convincing. Essentially, financial advisors are saying that everyone is different and needs individualized help, not blanket advice (don’t you think—when it comes to their finances, most people are mostly the same).

Robo-advisors have responded by adding financial advisors that you can talk to over the phone. Traditional financial advisors say their advice provides value beyond mere returns. (My answer: Fine, then bill by the hour, not as a percentage of assets under management.)

Robo-advisers emerged to cater to audiences previously ignored:

young people who are digitally savvy and aspiring and don’t want to be stuck in a stuffy office being tutored by a random financial advisor.

Think of a Google employee who doesn’t know what to do with his money that just sits in a checking account. Robo-advisors have done a good job of targeting this audience.

But the real problem here is, “Are they worth it?”

My answer is no – their fees don’t justify what they offer. The most popular robo-advisors have great user interfaces, but I’m not willing to pay for them. Since opening, many robo-advisors have reduced their fees, sometimes even lower than Vanguard.

The problem with robo advisors

But there are two problems with that: To run a sustainable business with fees below 0.4 percent, they need to offer new, more expensive features and manage huge amounts of money — we’re talking trillions of dollars.

For example, Vanguard currently manages nine times more assets than Betterment and ten times more assets than Wealthfront. This sheer, massive size is a huge competitive advantage for Vanguard, which has built itself over decades to cope with tiny, fractional percent fees.

New robo-advisors can’t afford these low fees unless they grow their business quickly, which is unlikely. Instead, they’ve raised money from venture capitalists who want rapid growth.

To attract more clients, robo-advisors have started using marketing gimmicks like highlighting a tiny portion of the investment, “collecting tax losses” — which is basically selling an investment aimed at offsetting tax gains — which they appear to be making have blown up a critically important part of an account.

Why Collecting Tax Losses Isn’t So Important

That would be like an automaker spending millions of dollars to market a triple coat of paint as one of the most important parts of buying a car. Sure, lost tax revenue can save you a little money in the long run. . . But not many.

And in many cases it is unnecessary. It’s a “nice to have” feature, but hardly something to base your important decision on which company to invest your money in.

Some robo-advisors have also started offering products with higher fees, the Wall Street Journal reported in 2018.

Wealthfront added its own, more expensive fund. The offering uses derivatives to replicate a popular hedge fund strategy known as “risk parity”.

Some clients — along with consumer advocates and competitors — quickly took to online forums to criticize the fund’s cost and complexity. They also tasked Wealthfront with automatically adding certain clients to the fund.

“I just checked my account and it’s true. Money was transferred to your Risk Parity fund without my consent,” Wealthfront client Cheryl Ferraro, 57, of San Juan Capistrano, Calif., recently wrote on Twitter.

“I had to go into my account and tell them I wanted my money taken out of this fund. It certainly shook my faith in her,” Ms. Ferraro said in an interview.

This is the predictable result when a low-cost provider takes on venture capital and needs to grow quickly. It either finds more customers or finds a way to make more money from each customer.

The final result

I believe Vanguard has the advantage and I invest through them.

But realize this: If you’ve narrowed down your investment decision to a low-cost provider like Vanguard or a robo-advisor, you’ve already made the most important decision of all: making long-term money growth, low-cost investments.

Whether you choose a robo-advisor or vanguard or other low-fee broker is a small detail. Pick one and move on.

Pick one and move on!