When it comes to investing, there are only a few rules you need to follow to do it well.
Boiled down to just the essentials, good investing is actually pretty simple.
Of course, that doesn’t make it easy.
From my experience, the biggest obstacle to getting started and sticking to a plan is simply the sheer number of options to choose from.
Between the different types of retirement accounts, the thousands of investment options available to you, and the strange words and acronyms used to describe all of them, it’s hard to feel confident that you’re making the right decisions.
Which is exactly what makes robo-advisors like Betterment, Wealthfront, and others so attractive.
Robo-advisors are essentially just automated investment platforms that do a lot of the “figuring out” part of investing for you. You decide how much you want to save and they choose and manage the investments for you.
Which is great! The easier it is to get started investing, and the easier it is to maintain, the better.
So, should you be investing with a robo-advisor? Are there other options available to you that might be better?
Let’s figure it out together.
Pros of using a robo-advisor
1. Easy to get started
By far the most important part of investing is simply saving money. Nothing else even comes close in terms of impact.
And this is an area where robo-advisors really excel. You can often be up and running in just a few minutes since many of the tough decisions are already made for you.
Robo-advisors have made it easier than ever to start investing. That’s a big plus.
2. Relatively inexpensive
The biggest robo-advisors out there today all build their investment portfolios using high-quality, low-cost index funds.
This is a big deal, both because index funds have consistently outperformed other types of funds and because cost is the single best predictor of future returns.
Robo-advisors give you access to high-quality investments at a low cost. Win-win!
3. “Good enough” investing
A lot of people make the mistake of thinking that there’s a perfect investment strategy out there. That leads to a lot of wasted time and bad behavior that only serves to hurt your returns.
There is no perfect investment strategy. Rather, there’s a wide range of investment strategies that are good enough to help you reach your goals. Your mission should be to land somewhere within that range.
While every robo-advisor has a slightly different strategy, for now all the major players fall in the camp of “good enough”. That doesn’t guarantee anything, but it does increase your odds of success.
Cons of using a robo-advisor
1. Extra management costs
Almost every robo-advisor charges a small management fee on top of the underlying fees of the funds they use. After all, they have to make money, right?
While this fee is typically small, it does add to the cost of investing. And since cost is pretty important to your long-term success, every extra fee matters.
Here’s a post that compares the cost of some of the major robo-advisors: Which Robo-Advisor Has the Lowest Fees?
2. No true financial planning
Real financial planning involves much more than your investments. Investing is just one piece of the puzzle that can help you use your money to create a life you enjoy.
And the issue here is when these platforms present themselves as financial advisors, instead of simply automated investment platforms.
Because so far they are not actually looking at your entire financial picture and recommending the best course of action. They are simply helping you decide whether to invest in Portfolio A or Portfolio B.
A few weeks ago I wrote about the dark side of free financial advice, and this was one of the examples I gave. A robo-advisor will always recommend that you invest your money over something like paying down your student loans or buying insurance for the simple fact that they only make money when you invest. It has little (or nothing) to do with what’s actually best for your specific goals and needs.
So while these robo-advisors can be a great source of investment advice, they are not yet a good source of overall financial advice.
3. No behavioral coaching
One of the hardest and most important parts of investing is sticking with your plan when everyone else around you is freaking out.
When the market is up, the temptation is to get more aggressive to take advantage of the big returns. When the market is down, every bone in your body is going to want to get out before all of your money is gone.
And in most cases giving into those urges is the wrong decision. It may feel right at the time, but it’s really just an effective way to significantly lower your returns.
Unfortunately, most robo-advisors make it easy to act on these impulses. It often only takes a few clicks to dramatically change your investment strategy and there’s no one there to talk you out of it.
In other words, while a robo-advisor can help you create a great investment plan, it won’t help you stick to it when the going gets tough.
Alternatives to investing with a robo-advisor
While robo-advisors have a lot of good things going for them, they aren’t the only option. They aren’t even the first companies to offer all-in-one investment portfolios.
Here are three other options to consider.
1. Target date funds or balanced mutual funds
The robo-advisor model of making it easy for people to invest in a broadly diversified portfolio with an appropriate asset allocation is not a new one. They’ve simply used technology to make it slicker and sexier.
But companies like Vanguard have been offering both target date retirement funds and other all-in-one funds for years that essentially serve the same purpose. They combine multiple mutual funds into one so that you can get an entire investment portfolio with a single investment.
They have some of the same downsides as robo-advisors, like the lack of financial planning or behavioral coaching. But they can also be less expensive since they don’t have the management fee on top.
Personally, I don’t see much of a difference between these funds and robo-advisors. So it really comes down to which investment strategy you prefer and what the costs are.
Of course there’s no need to use a pre-made solution. You’re welcome to choose you own mix of funds and implement it across your various investment accounts however you’d like.
There’s more work and complexity involved with this approach, but with the benefit of more control over what you’re investing in. It also allows you to take advantage of some more advanced techniques like asset location that may result in a small increase in returns.
3. Financial Planner
The final alternative is to get the help of a financial planner.
The big downside to this approach is the cost. It will almost always cost more up front to go this route, and in many cases those costs are hidden.
But there are some big potential advantages too.
The first is that if you choose the right kind of financial planner, he or she will help you improve ALL areas of your financial life, not just your investments. The overarching goal will be helping you use the financial opportunities available to you to create a life you enjoy.
And the second is that you’ll benefit from behavioral coaching, which research shows can add as much as 1.5% per year to your investment return. That alone may be worth paying for.
So how do you find a good financial planner? And even more importantly, how do you avoid a bad one?
This post will help you do it: How to Find the Right Financial Planner for YOU.
Robo-advisors are great, but not the only option
My honest opinion is that robo-advisors are a fantastic step forward for investors. They’ve made it easier than ever for you to access high-quality, low-cost investments, which is absolutely a good thing.
So yes, a good robo-advisor is likely to be a good place to invest.
But it’s important to understand that they don’t fix everything. They can’t guarantee returns any more than anyone else can (which is not at all). And they don’t help you create a financial plan that encompasses all of your personal and financial goals.
They’re simply an investment tool. A very good one that can be used very effectively, if you understand the limitations and plan accordingly.
Do you use a robo-advisor? What’s your experience been like so far?