The rise of robo-advisors occurred shortly after the 2008 financial crisis. Positioned as a digital solution to the many overwhelming factors involved when trying to build an investment portfolio, it’s often marketed to Millennials – but it’s certainly not just for the 22 to 39-year-old demographic.
Seriously though, what are robo-advisors?
In simplest terms, a robo-advisor is a digital platform that’s used to handle your investments. The process usually starts with you answering a questionnaire that helps determine your risk tolerance and goals, which both then help inform how you should invest your money.
But there’s a lot more human touch occurring than you probably think. Yes, robo-advisors do use algorithms, but somehow those aren’t able to time or beat the stock market. You will still weather the ups-and-downs just like everyone else. Many, but not all, robo-advisors also provide access to human advisors so you can speak to a professional when you need advice.
The upside of robo-advisors
It’s completely possible to be a Do-It-Yourself (DIY) investor. But with that comes the additional challenge of needing to rebalance your investment portfolio and evaluate opportunities for tax-loss harvesting – a fancy way of offsetting taxes and increasing returns. You may find you don’t want to be that hands-on or that you feel a little overwhelmed at the process as a rookie investor. A robo-advisor can help automate that for you instead of you needing to tinker around with it yourself.
Most robo-advisors offer online learning platforms in the form of blogs, calculators and videos. It’s a great way for you to keep educating yourself about the market.
Many of them also keep in touch with you via email and remind you to keep calm and carry on when the market takes a tumble. Sure, it’s not a dedicated advisor, but you may need that quick reassurance, even if it’s in the form of an email.
The potential downsides of robo-advisors
One of the most critical factors when investing is to evaluate the fees. Every investment dollar you lose to fees is a dollar that’s not growing for future you. Robo-advisors do come with higher fees than the DIY investor option of going directly to a brokerage firm. The fee is usually still lower than what you’d get with a dedicated planner though.
While you may have the option to speak to a human advisor, you could find it harder to have an on-going relationship with one particular person. That can get stressful if you have to re-explain your situation time-and-time again instead of working with a dedicated planner who always knows your plan.
What happens if the robo-advisor fails?
Because robo-advisors are still fairly new on the investing scene, people understandably get nervous about their longevity. There are two things you need to look for and understand when it comes to robo-advisors or any type of investing.
First, is it SIPC insured?
Securities Investor Protection Corporation (SIPC) is similar to FDIC insurance on your checking and savings accounts. The SIPC will provide up to $500,000 of protection for your securities (aka investments) if the brokerage firm you use closes due to bankruptcy. You want any brokerage with which you do business to be SIPC insured.
Second, it’s important to understand you’re not investing directly in the robo-advisor itself.
You’re probably investing in index funds, an exchange-traded fund (EFT) or maybe even some individual stocks. If the robo-advisor ends up going out of business, you can do what’s known as an in-kind transfer. You would just move your current investments from that robo-advisor to a new brokerage or other robo-advisor. By making that move, you aren’t selling or buying new investments.
Always do your due diligence
Yes, most robo-advisors are safe, but you should always do your own research. Check reviews. Ask friends and co-workers who they use and how they liked it. It’s always great to test out the customer service to ensure you like the options you have to talk with a human and get your questions answered.