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While portfolio automation technology has been around since the 2000s, the use of robo-advisors in investment management has skyrocketed in recent years. However, the question “what are robo-advisors?” still crops up often, and many investment managers and individual investors are still unclear on whether they should be using robo-advisors or not.
In this article, we unpack what robo-advisors are and the pros and cons of using robo-advisors. We also explore what you need to know when considering using robo-advisors for your own investment management needs.
So, what are robo-advisors?
Robo-advisors are digital platforms that provide automated, algorithm-driven financial planning services with little to no human supervision. The first robo-advisor, Betterment, was launched in 2008 and had the primary objective of assisting the management of buy-and-hold passive investments. The technology was no novelty, as wealth managers were using automated portfolio allocation software since the 2000s. However, before Betterment’s introduction, only wealth managers could purchase the technology, so customers, therefore, had to hire financial counselors in order to benefit from the innovation themselves.
The pros and cons of robo-advisors
Robo-advisors for retail investors have gained a lot of popularity in the past few years, due to their ease of use for new investors and low associated costs, essentially breaking down the barriers to entry for investing.
Robo-advisors present several benefits, such as:
- Low costs: Robo-advisors generally have lower fees than traditional financial advisors, as they are based on algorithms and automation.
- Ease of use: Most robo-advisors have user-friendly platforms that are easy to navigate for first-time investors, making setting up an account, reviewing their portfolio, and making changes to their investments very straightforward.
- Diversification: Robo-advisors often use diversification as a key component of their investment strategies, which can help reduce risk and improve returns for investors.
- Customization: Many robo-advisors allow investors to customize their portfolios based on their goals, risk tolerance and other factors, such as industry preferences.
Although robo-advisors are easy to use for first-time investors, they also have downsides worth being aware of, including:
- Limited personalization: While many robo-advisors allow investors to customize their portfolios to some extent, they don’t offer the same level of personalization as traditional financial advisors. This can be problematic for investors with complex financial needs or those who are looking for a high level of customization.
- Limited investment options: Some robo-advisors may have a limited selection of investment options, which can restrict the diversification of portfolios.
- No human interaction: While some robo-advisors offer the option to speak with a human financial advisor at some point in the process, others do not. This can be a problem for investors who prefer to have the option to speak with a person or have complex financial questions that require a human touch. This can become an issue if you need to make changes to your portfolio or have questions that can’t be answered by the platform itself.
- Dependence on technology: Robo-advisors rely on algorithms and technology to manage portfolios, which means they can be subject to technical issues or glitches. New companies especially can be subject to this technological risk.
Should you use a robo-advisor?
Individuals with complex financial needs or a large, diversified investment portfolio might be better served by a traditional advisor who can provide more personalized guidance. Additionally, some investors may prefer the human element of working with a financial advisor and may feel more comfortable discussing their financial goals and concerns with a person rather than an automated platform.
Ultimately, whether a robo-advisor is right for you depends on your individual financial situation and needs. It’s important to carefully consider your options and do your research before deciding which investment strategy is best for you and whether that strategy includes the use of robo-advisors.
Summary
While robo-advisors have revolutionized investment portfolio management for investors with their benefits and capabilities, there are also drawbacks to using them that you should consider when exploring using a robo-advisor. Take into account your own financial and investment needs, as well as your investment strategy, before deciding whether to use a robo-advisor or not.
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