Robo advisors are an excellent alternative to traditional human financial advisors. These digital platforms offer automated investment management advice. Complex algorithms and asset allocation mechanisms empower them. The main benefit of robo-advisors is their ability to work without human intervention. But before you start using robo-advisors, it is worth being aware of their pros and cons.
Pros of Robo-Advisors
First, let’s examine the benefits of robo-advisors. These reasons should tempt you to start using them.
Cost Savings
The most prominent benefit of robo advisors is the ability to save money. The annual cost of a robo advisor would be around 0.25% to 0.50%. This is much lower when compared to the 1% cost of human advisors. In the long run, this can help you save thousands of dollars.
Accessibility
You canors 24×7. That’s because the digital platforms are available 24 hours a day. Hence, monitoring performance and changing your investments will not be challenging, regardless of the time. This self-service model also allows investors to have better control over their investments.
Unbiased Advice
Most robo-advisors use algorithms to recommend portfolios based on an investor’s risk tolerance, goals, and time horizons. Their computer-generated advice is unbiased and not influenced by commissions or self-interest. Their recommendations are based solely on data-driven insights and research.
Account Minimums
Many established robo-advisors allow people to open accounts and start investing with little or no money. Most have no minimum or require between $500 and $5k to get started. This makes automated investing more accessible to new investors than the often higher minimums human advisors require.
Tax-loss Harvesting
Tax-loss harvesting is an automated service many robo-advisors provide that helps lower investors’ tax bills by realizing capital losses to offset gains. Traditionally, this required manual oversight and selling/buying from a human advisor. Automating this through algorithms can provide incremental tax alpha, especially for more extensive portfolios.
Cons of Robo Advisors
Similar to the benefits, there are some drawbacks to robo-advisors. Here are a few of them.
Limited Human Interaction
The most commonly noted disadvantage of robo-advisors is the lack of direct human interaction and advice customization. While their tools and content provide substantial guidance, they generally cannot offer personalized advice tailored to each investor’s unique goals and needs. There are also limited options to discuss complex financial planning issues.
Lack of Hand-holding in Volatility
While robo-advisors provide unbiased advice that is not swayed by emotion, some investors prefer having a human advisor provide reassurance and help them talk through their concerns during periods of market volatility. Robo-advisors do not provide that type of hand-holding or behavioral coaching.
Complex Situations
Robo-advisors are designed to manage simple, long-term ETF-based portfolio investments. They cannot handle unique or highly complex situations that a human advisor could navigate, like concentrated single stock positions, specialized tax circumstances, estate planning, trusts management, and more sophisticated options-based strategies.
Minimal Portfolio Customization
Most robo-advisors algorithmically match clients to a limited number of pre-made portfolios. While these selections are based on sound modern portfolio theory, investors cannot fully customize or request modifications to the portfolio selections or asset classes used.
Pros of Financial Advisors
Financial advisors can also benefit you in numerous ways. Here are a few ways how they can be helpful.
Personalized Advice & Planning
The main advantage human financial advisors offer compared to robo-advisors is fully customized 1-on-1 advice and financial planning guidance based on an investor’s unique needs and goals. Advisors get to know their clients personally and provide individualized portfolio management paired with tailored financial plans across retirement, taxes, insurance, estate planning, and special situations.
Behavioral Coaching
In addition to advice, one of the most valuable services a trusted advisor can provide is behavioral coaching. Drawing on their experience from different market environments, a skilled advisor helps investors stick to their long-term plans and avoid emotionally driven decisions around market swings.
Complex Situations Management
Human advisors excel at helping investors navigate specialized or complex financial situations. These could include concentrated stock positions, restricted stock units, intricate tax scenarios, trusts management, options strategies, and estate planning beyond basic wills. Most investors will encounter at least some situations requiring higher-level oversight.
Ongoing Relationship
When an investor works with an advisor for many years, the advisor gains valuable context and familiarity with the investor’s situation. This facilitates proactively making appropriate recommendations as needs and goals evolve, rather than requiring the investor themselves to continually update and manage their situation with an automated platform.
Cons of Financial Advisors
As you can see, working with financial advisors has drawbacks as well. Let’s quickly explore them.
Higher Fees
The number one drawback of traditional human financial advisors is their much higher cost structure than robo-advisors. Advisors must charge higher fees to cover their personalized time and overhead expenses. Management fees over 1% per year plus commissions or fixed fees for financial plans are standard. These costs noticeably eat into long-run portfolio returns.
Varying Levels of Skill
While the best advisors capably deliver value well above their fees, industry skill level varies greatly. Sorting between veteran advisors who demonstrate genuine fiduciary duty rather than peddling commissioned products presents another research challenge for investors. Subpar advice can cost more in improper guidance than the fees charged.
Perceived Conflicts of Interest
Even advisors with strong skills and intentions often face perceived conflicts of interest. Many receive compensation based on assets under management or commissions on recommended products. These standard practices cast doubt around whether the advice is entirely objective versus influenced by potential incentive biases. Identifying advisors who follow the best interests and fiduciary standards helps overcome this concern.
Account Minimums
Top financial advisors often set high account minimums of several hundred thousand dollars due to client servicing capacity constraints and fixed costs like financial planning fees. This puts comprehensive financial advice out of reach for many Main Street investors unless they have already built up savings and investable assets.
Conclusion
Both robo-advisors and human financial advisors offer attractive benefits and different downsides. A hybrid approach leveraging both providers can also be taken. The best option depends greatly on each investor’s unique preferences, needs, and financial circumstances along their journey. Carefully weighing these pros and cons allows finding the right fit.
