The Pros and Cons of Robo-Advisors
Robo-advisors have been on the rise in the financial industry, offering automated investment management services to individuals and businesses. Through leveraging algorithms and AI to manage portfolios, these platforms seek to become a low-cost way to put your investments on autopilot. Convenience is key, but are they sophisticated enough to be trusted with our life savings?
To help summarise the value of robo-advisors, we have compiled a list of pros and cons before comparing them to more traditional ways to manage wealth.
The benefits of using robo-advisors
Robo-advisor platforms often invest heavily in their own mobile apps. Such fintech companies focus strongly on customer experience making these some of the easiest-to-use platforms around. The silicon-valley blitzscaling and high amounts of funding early on allows them to do this. Though, customer service may not be comparable to the app experience.
Furthermore, the idea behind robo-advisors is to simplify your portfolio. You hand them money (or set up a direct debit), tell them your risk profile and goals, and they take care of the rest. This is their unique value proposition.
This simplicity creates their biggest strength of all: making investing accessible. Investing often requires confidence because there is a knowledge hurdle, and the stakes are high. But, the convenience and autonomy of these platforms give ordinary people the confidence to start growing their wealth. Furthermore, they’re likely protecting many retail investors from making poor investments and beginner mistakes.
Cheaper than active fund managers
A robo-advisor costs an annual flat fee of around 0.2%-0.5%. This is cheaper than both active fund managers and human financial advisors. Whilst it isn’t the cheapest way to invest, it’s fair to categorise it as low-cost passive investing which is a strategy recommended by Warren Buffet, among many others.
Robo-advisors take the approach of index investing, which is essentially investing in many different companies around the world. Whilst they do not diversify much beyond equities and bonds, there’s usually a good amount of diversification within these asset classes. Some robo-advisors will consider other assets like real estate and commodities, though these would be REITs and ETFs respectively. For those that do utilise a mix of asset classes, this is perhaps more diversification than many beginner investors would do themselves.
Tailored to your needs… Sort of
Robo-advisors ask customers for their risk profile through a series of multiple-choice questions. From here, along with stating your goals and basic situation, a strategy is employed accordingly. To some degree, this is tailored to your needs, but inevitably in a limited capacity. Nonetheless, it provides a portfolio that reflects your goals and appetite to risk which, again, helps mitigate having a misaligned portfolio.
The disadvantages of using robo-advisors
An expensive way to invest in index funds
Whilst some robo-advisors have a few other services beyond investing, most of their business revolves around investing in index funds. The majority of Vanguard’s ETFs cost between 0.08% and 0.40%, which is less than the typical robo-advisor fee of 0.2%-0.5%.
Furthermore, many stock trading platforms have free ETF trading, meaning you can actually hold index funds for free - along with commodity trackers and the like. When considering the value of compounded gains, small differences in fees can really hinder gains, and ultimately the same portfolio could be constructed for cheaper.
Lack of personalisation
Whilst a robo-advisor can choose an asset mix of ETFs and bonds that reflects your risk level (your risk level is determined through a basic survey), this is about as far as it goes when it comes to personalisation. Relying on an algorithm to choose and manage your portfolio inevitably has its limitations.
One way this is highlighted is because it doesn’t take a holistic approach to your finances. It’s not taking your other investments, like property, into consideration, or your tax liabilities, business, workplace pension, and so on. You won’t receive sophisticated estate planning strategies, for example.
Lack of expertise
Robo-advisors are nothing more than autonomous algorithms, lacking in intuition, context, and resources. When it comes to investing itself, there may be sub-optimal decisions made along with missed opportunities due to their limited expertise. For example, many foreign investors are currently investing in the FTSE 100, helping it reach a record high. One reason for this might be because of the depreciation in the pound, where the weak currency itself becomes a hedge against the stock price. This is a consideration that would be missed by the robo-advisor’s basic algorithm.
It could be more diverse
A robo-advisor can never invest in the same range of assets as when investing manually or through a financial planner. Holding physical property for AirBnB through a mortgage, for example, is not achievable. Furthermore, your business or career can sometimes be another way to diversify - perhaps the owner of a small estate agency wouldn’t want to invest in many REITs - which a wealth manager may pick up on, but a robo-advisor would not.
Robo-advisors are often in the discussion of whether or not they can replace financial planners and wealth managers. However, this is perhaps the wrong way to look at it. Because they are so far away from replacing these services, they are better compared to being your fund manager - you hand them money to invest in stocks, bonds, and some funds. Whilst they may dabble in some other services (sometimes tax harvesting), it’s more accurate to think of them as competing against Vanguard. Or at least, operating somewhere between the two.
In this context, they are more convenient, accessible, and less intimidating than Vanguard for beginners. You’re not going to get better returns because the investments made are almost the same. But, they may be able to aid with assessing your risk profile better than Vanguard's help guides. You pay a higher management fee for these luxuries, which likely are not worth it unless the retail investor is a complete beginner or psychologically does not want to be responsible for constructing their portfolio. Another consideration is that it’s difficult to argue that they are as credible as the likes of Vanguard and Hargreaves Lansdown.
For bespoke guidance on your portfolio, get in touch with a Moneytree Wealth Management advisor. Moneytree Wealth Management provides expert advice and guidance on growing wealth through diversified investments and tax minimisation.