As most regular readers of this financial planning blog know, I used to be a professional Certified Financial Planner for several years. That gave me a lot of insight into just what a financial advisor does and does not do for his or her clients, and how much that is worth.
Susie Orman is a former financial planner who decided that the whole profession was basically rubbish. Other former financial advisors are now out there saying that these professionals are indispensable. The truth, as with most things lies somewhere in between. So, how does a robo-advisor stand up to a real financial advisor?
Robo-Advisor vs Financial Planner
Let’s start with getting some facts straight. First, robo-advisor is a fancy, sensational term for bold headlines. The reality is that the so-called robo-advisors are actually computer programs that build and investment portfolio, usually out of mutual funds and ETFs, for you. There are no robots sitting behind desks anywhere (although that would be cool.) Second, a robo-advisor really isn’t an advisor or financial planners so much as an investment manager.
The reason these things matter, is because, unlike most people’s perceptions, investing your money is actually not the most important thing a typical financial advisor does. The days of a fast-talking New York broker calling you and screaming, “Buy!” or “Sell!” into the phone are pretty much over. For almost everyone without a million dollar portfolio, the only thing your human financial planner will ever do with your money is put it in mutual funds or exchange traded funds (ETFs) which will actually handling the buying and selling of stocks for you.
Believe it or not, many advisors don’t have that much variety in their investments between customers. Most advisors working with clients that have less than $1 million dollars of investable assets, aren’t out there determining which mutual funds are best for you specifically. Instead, they determine which mutual funds are the best to use for their customers overall, and then slot each individual into those funds using individual percentages. If you and a friend have the same advisor, compare your portfolios some day. You’ll see a lot of the same investments, even if the percentage amounts in each investment are different.
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A robo-advisor does essentially the same thing. The company, using whatever method they think works best, selects a portfolio of investments to be used by the robo-advisor. This field of investments is the same for all clients. What changes is what percentages of your money goes into each investment. Then, certain investments are added, or removed, for more or less risk tolerance.
For example, if you are young, and profess a high risk tolerance, you might get a specific small cap international fund, or a micro-cap fund. On the other hand, if you are nearing retirement and profess a low risk tolerance, those funds will not be in your portfolio at all. We recently reviewed Acorns, an app that transfers small amounts of money into an investment account run by a robo-advisor. Your funds are all invested in pre-chosen portfolios run by computer, or robo-advisors.
Now, neither the robo-advisor, nor the human advisor, have a single portfolio used by everyone, but you’ll find a small stable of investments in common used among most all of their clients.
Note that this all changes once you have more than approximately $1 million worth of investable assets. At this point in time, certain financial advisors start calling themselves wealth managers, and they will build portfolios for you out of individual stocks. The reason for this is two-fold. First, at about this dollar amount, you can actually buy enough individual stocks to achieve the proper diversification for a smart portfolio. Second, at about this amount, your financial advisor needs become a lot less about financial planning, and a lot more about making the money you already have earn more. (Think about it. If you have a million dollars out there being invested, do you really need a plan to pay for your kid’s college education? Just use some of your money. That’s your plan.)
Which Is Better Robo-Advisor or Human Financial Advisor?
Overall, the robo-advisors are likely to have better investment returns than human advisors over a long period of time. That is because human advisors charge higher fees. As long as you aren’t using bozo-style mutual funds, the difference, over the long-term, in diversified investment portfolios is often relatively small. This is sort of the point of diversification, to take the big volatility out of investing. However, the constant drag of higher expenses should make robo-advisors out-perform over time.
However, that out-performance may be relatively small. Especially, for people without a large investment portfolio, saving the right amount, the right way, is far more important than how much money your investments return. A person starting at zero, earning just 7% but saving 10% into their 401k will have oodles more money upon retirement than someone earning 10% but only saving 7%. Mistakes along the way like borrowing from your 401k or withdrawing early from an IRA will cost you much more that high fees. And these are exactly the kinds of things a human advisor can sit down and help you avoid.
In the end, whichever kind of advisor actually makes you get started saving and investing is the right one for you. If you are the kind of person who will open an account at 2:00 in the morning, but won’t call to schedule an appointment with a human, then go with a robo-advisor. If you’re the kind of person who is afraid to hit submit because you want someone to double check your work, then go with a human advisor.
We’ll break down some of the different robo-advisors here on Finance Gourmet in upcoming articles.