When I first heard about “robo advisors” I thought there were stupid. My investing system was simple and awesome so I thought there was no way robo advisor performance could improve it. But then…I gave a robo advisor a bunch of my money and it turns out they are awesome! And it’s NOT for some complex financial model they have. Its a pile of small, time savings at the cost of TINY fees that make it amazing! I love saving time!
The question we will answer today is: What are robo advisors and how does robo advisor performance stack up against the human-kind?
Every investor should know about these little computer angels, so, after a quick overview, we’ll hone in on the advantages and disadvantages of using robo-advisors. Plus the one trap they are hoping you will fall into.
Table of contents:
- What is a robo advisor
- A brief history of robo advisors
- How robo advisors work
- 7 reasons why robo advisor performance is great
- 3 Criticisms and why I don’t care about them
What is a robo advisor?
Robo advisors allow online investors to largely automate the act of investing. You don’t need your own input and you don’t need to talk to a sales-person ever. They range from very complex, Nobel Prize-winning algorithms services to simple automation of your simple index investing portfolio.
Robo advisors do these chores automatically, and that is where they help us. By saving our time.
Humans can do the same thing but as you will learn today the robots are better at it.
Where robo advisors come from and why robo advisor performance is so good (answer: A LOT of research)
Computers have obviously always been involved in investing but it was in 2001 that computer aided investing really started to change.
In 2001, IBM and HP released some studies showing that their simulations coupled with computer-driven trading could outperform human traders. Now those studies were run by huge super-computers but banks love money so they started really investing in making better-automated trading machines.
Then 7 years later after enough research had been done, entrepreneurs started to see an opening for bringing this bank-based robo advisor performance to the masses. So companies started popping up that anyone could sign up with.
Betterment which started up in 2008 was the first to really release something two years later in 2010. They had a pretty complicated model which was based on two theories which both ended up winning Nobel prizes. Wowzers!
Investors liked the simplicity and the fact that they could personalize the robo advisors for specific portfolios without paying huge fees to a human financial advisor. Then bada-bing bada-boom trillions of dollars were invested with robo advisors.
How robo advisors work?
The methods these robo advisors use can be pretty simple or pretty complicated.
At the base level though there is a lot of repetitive stuff that happens in an investment firm to automate. Portfolio re-balancing is a good example. If you are running a big mutual fund and you are supposed to have 30% of your money in bonds you have to keep buying and selling things to stay at 30% bonds.
Some people set up what the robot is allowed to buy and sell then over the course of your portfolio’s life, so no people need to be involved, thus no one needs to get paid a salary…saving you money.
Couple that with some fancy economics models which predict what is good to buy and sell and you have a robo-advisor. Repetitive tasks (+ optional computer simulations) = robo-advisors.
You’ll see though, I’m not even in it for the fancy models. Just getting the robot to automate our repetitive tasks. Fancy models cost extra money which I don’t care for.
7 Reasons Robo Advisors are AWESOME
Reason #1: Advisors Save Clients Lots of Time
Saving time is always my #1 reason for everything!
By handing off control of your investments to someone else you no longer have to do any work for your financial future. The amount of time you’ll save with an advisor can add up to dozens of hours per week if you compare yourself to amateur stock pickers or just a few hours a month for index investing folks. Either way, time savings!
Even if you have the simplest of investment strategies, you still have to deal with funneling off some money on every paycheck, transferring it, investing it and resolve portfolio re-balancing when needed.
It’s not a huge deal but it’s another task for you to deal with every 2 weeks. I hate tasks clogging up my mind so that was a big factor in my movement to robo-advisors. This is the highest form of robo advisor performance. They save you a surprising amount of time.
Also, you don’t want to become one of those “do-it-yourself” investors who pore over spreadsheets and crunch numbers in their spare time. Some turn the chore into a hobby but try rebalancing a portfolio, or tax-loss harvesting while you are supposed to be on vacation. It can be a real bummer and your investments don’t take vacations (which is a good thing!).
Then you know what? If you change your entire investment strategy or allocations, you can just re-set your preferences with your advisor any time you want and it will do the rest. Check-in quarterly or not even.
The ability to “set it and forget it” is something many robo users enjoy most.
All this time saving is true for human financial advisors or a robot financial advisors but robo advisors have 6 more advantages! Wooooeee!
Reason #2: Robo Advisor Fees are Much Lower Than Human Advisor Fees
Robo advisor clients save big on fees and opening balances. Ongoing fees are the key advantage of robo financial advisors compared to human financial advisors. Ongoing fees for robo-advisors range from 0% to 0.5% of total portfolio assets. Those fees are tiny, you get all that robo advisor performance for almost no money.
Humans charge way more than that! They want that money so they can go retire too. So they charge around 2% (and, yes, sometimes it comes to much more than that). While that 2% might not sound like a big deal it is a big deal.
We’ve talked about this before but that extra 2% management fee that gets charged will really torpedo your investments. Just look at how much of a loss over 10 years a 2% fee costs you.
Reason #3: Long-Term Robo Advisor Performance is Commendable
Robo advisors can get really fancy and try to do some complicated stuff. The basic ones though (which have super low fees!) just trade around a few large index ETFs (which is great!) and hold onto some specific portfolio allocation. Then since its simple, the fees are super duper low. Oh baby!
Trading index funds is a simple strategy, but it meets the average returns of the market and as you can see in this report, that also means it beats out 99% of human fund managers.
So, we have low fees, great returns, and it saves our time? How could this get any better?
Well it does. Welcome to robot heaven.
Reason #4: Performance-Tracking Features are Extremely Helpful
Your robo advisor performance results are completely transparent and easy to understand. All of these financial services come with performance-tracking features that let you see where you stand in terms of sector balance, in-sector diversification, total returns, tax liability, and many more parameters.
Tracking your performance isn’t a horrible activity to do with Google sheets or Excel but your advisor is doing it for you! Want to see how you’ve done? Just hit the report or performance tracking button and everything is there.
That means you’re never left wondering how your portfolio is doing. You don’t need to call your advisor and ask a bunch of questions or email the brokerage for weekly, monthly or quarterly updates.
Then they’ll summarize it all nicely for you at year end for you to fill out all your taxes! This is all the time savers rolled into one. This is heaven for me.
Reason #5: Robo Advisor Come With Minimal or Zero Opening Balances
Human advisory services are notorious for high opening balances. If you don’t have tens of thousands of dollars, you can’t even talk to many human advisors.
Recently, some of the larger brokerage houses have begun trying to compete with robo advisors by offering lower opening balance requirements, but you have to pay to play. Even in best-case scenarios, expect to plunk down a few thousand bucks to open an account with a human advisor. Worst case, account minimums are $5M!
Robo advisors not only beat their human counterparts, with lower fees but they come with minimal or zero opening balances. Few comparisons mention this point or include it when calculating rates of return, but it makes a huge difference when you are starting out.
If you have to shell out $10K just to start investing, and that takes a while to save up, your annual return has already taken a massive hit before you even got in.
Reason #6: Robo Advisors Help You Avoid “Emotional Investing”
By their very nature, automated investing tools help human investors avoid the pitfalls of emotion, which has no place in for-profit asset management. It’s easy to be tempted by a “hot stock tip” or the newest fads in the market. Ask anyone who ever purchased a micro-cap that went bust or still owns shares of First Solar or CenturyLink, both darlings of the investing world at one time.
Developing a system that allows you to avoid emotional reactions to stock market events is a HUGE part of investing. You can invent all sorts of complicated rules for yourself
Pay the tiny fees to an emotionless robot and not watch what it gets up to. No opportunity for emotional outbursts, and LOTS of opportunities for napping instead.
Reason #7: Robo Advisors improve your taxes with ‘tax-loss harvesting’
No one wants to pay more tax than they have to so you will happily discover that robo advisors minimize your payout to the tax man each year. Robo advisors can preferentially buy and sell your investments to reduce your capital gains/taxable earnings each year through a process they call tax-loss harvesting.
The robots set up situations where they can farm tax benefits when they trade. If you’ve ever played an RPG or World of Warcraft you know farming is required for high performance and this bot is a pro at it!
A basic example of this is, investors can sell and re-purchase some investment that had a loss to offset taxable gains with short term losses without actually hurting your investments.
The important part: You could do this yourself but it can get complicated and time-consuming. The robot knows what it’s doing and now you don’t have to. Hurrah!
Also if you make a lot of money it can save you tens of thousands of dollars a year!
Tax accountants have been using this approach for decades and charging quite a lot for it.
There are some Disadvantages of Robo Advisors
I love robo advisors, but they do have some downsides that I think are totally irrelevant for me and you. Here’s a quick summary of the disadvantages and who this stuff really effects:
Downside #1: They do charge fees – A problem once you’re already rich
You could do everything yourself and save some money. Some people would rather fix their own cars, make home repairs with no outside help, and perform all the calculations on every single investment in their portfolios. It’s human nature.
Yes, it’s possible to save money by managing all the financial tasks associated with portfolio maintenance but the amount of time that you save isn’t worth it for the tiny fees that you pay until you have a lot of money, and at that point you are rich.
Everything costs money. Even though robo advisor fees are typically less than half of what human advisors charge, you’ll still need to pay for the smart folk who made the technology.
The trick though is they all charge fees as a percentage of your portfolio so here is the trick to make this work out:
- Invest with robo advisors that allow you to transfer out your funds with no fees or buy/sell transaction costs.
- Then once you have a lot of money and that percentage fee feels large you can transfer out your money.
- Namely, when you retire, you will have a lot of money AND more time. A perfect time to ditch the robots.
Downside #2: Robo advisors will not be your friend
Do you like people? Some investors demand human interaction and like the give-and-take of dealing with a personal advisor. Robo advisors won’t invite you on weekend golf outings, won’t call you with stock tips and won’t sit down over lunch to discuss your lifetime financial goals. If you want a relationship like that, robots are not for you.
I have two friends that have human advisors and won’t move on.
- One friend likes the relationship he has with his advisor person, he likes going out to coffee with the guy and he likes golfing for free once a year. This friend is old and I think these are the desires of an older generation.
- Another friend won’t leave her human advisor because her advisor also has a special needs daughter too and gave her lots of advice. Now she feels indebted.
Those are not financial reasons to be with a human advisor. If you want a partner I suggest you go to match.com not a financial advisory service.
Downside #3: Robo advisors will not soothe your mind
A human advisor can pat you on the head and tell you everything is going to be ok. Investing is scary sometimes and it can be nice to have a pat on the head. Our emotionless robots will not give that to us though.
To deal with this, you need to understand the facts and know that if you just keep investing when markets get rough, it will work out in the end.
So now that you know the facts, what’s stopping you from investing on easy street with robo-advisors? I’d love to hear about it.
TL;DR – Robo advisor performance and ease are worth the tiny fees
- Robo advisors deal with repetitive investing tasks to save us time.
- They also save us money by charging very little for their services.
- Robo advisor accounts are simple and cheap to set up.
- They can get pretty fancy and have nice things like tax-loss harvesting.
- If you want a friend though, or a mind soother, robo advisors might not be for you.
- I do recommend you ditch the robot once you are rich and retired, even though I like them.