Currently, only about one-half of one percent of all investment assets are handled by robot-advisers. However, it is estimated that by 2020 they will be responsible for approximately 5.6 percent of all financial assets. Since it is likely that companies will soon be promoting these robo-advisory accounts, it would be a good idea for all of us to understand them better.
Over Half of Retirees Personally Handle Their Investments
According to an article in the April / May 2017 issue of AARP Magazine, titled "Should a Robot Manage Your Money?" many people simply handle their own investments. According to them, only "52 percent of pre-retirees and 44 percent of retirees" actually consult with a human adviser. The reasons for this are complicated, but often boil down to the fact that they believe human advisers are expensive and they are unsure how to find one they trust. As a result, for better or worse, many people simply prefer to make their financial decisions without outside assistance.
How Does a Robo Advisor Work?
Robo advisers offer a variety of investment portfolio options, but they generally consist of stocks and bonds which are held in ETFs ... exchange-traded funds which are traded as stocks.
The robo adviser sends you an online questionnaire and they use your answers to choose the best combination of ETFs to put in your portfolio and meet your investment goals. Your account can be either a tax-deferred IRA or a taxable account.
The robo adviser will re-balance your portfolio periodically so it stays within the range of your target allocations. In order to help the robot, you can regularly update the questionnaire.
With a robo advisor, you do not have direct access to your investments. You cannot quickly move the money in response to the market. It is passive, long-term investing. Once you retire, robo advisors can continue to manage your portfolio, if you choose, and assist you in calculating the required minimum distributions which you need to take once you reach the age of 70 1/2. They can also help you choose which investments would be best to sell when taking the distributions.
How do Robo Advisors Perform?
According to the AARP article, there are no long-term studies which could help you compare results between humans and robots. Their article contained some hypothetical comparisons, which I will not report here, because they were based on their best guess, not on actual results.
Your actual performance would reflect the performance of the indexes behind the ETFs in which your account is invested. You would also have the advantage of low fees, approximately 0.25 percent of your portfolio value each year. Human advisers typically charge between 1 and 2 percent.
A robo advisor will re-balance your portfolio regularly. This would be accomplished by the automatic sale of investments which had gone up the most and investing the proceeds in investments which lagged. In other words, you would be selling high and buying low.
Robo advisors are considered very safe, conservative investment managers, according to the Consumer Action advocacy group, because the accounts are so widely diversified, re-balanced regularly, and invested for the long term. They are covered by SIPC insurance or the Securities Investor Protection Corporation. It does not protect investors against loss, but does protect them if the financial institution goes broke.
What do Investors Lose by Having a Robo Advisor?
The most important thing you would lose by having a robo advisor is human advice. The robots cannot answer your questions, or make recommendations regarding other aspects of your financial plan, such as the best time to take Social Security, whether or not you should get an annuity, or provide assistance with similar decisions.
More Thoughts about Robo Advisors
It is possible to have a hybrid solution. For example, Vanguard's Personal Advisor Services combine a human advisor with a robo advisor.
Robo advisors are not right for everyone. Some people may be more comfortable either handling their investments themselves or dealing with a human who can explain their investments to them and help with other financial decisions. However, for the 5 or 6 percent of investors who will be using robo advisors in the coming years, it is important they understand how they work, as well as the advantages and disadvantages of using them.
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