Robo-advisors are really cool robots that are programmed to follow you around and give you advice. Ok, not quite, but they are still pretty cool.
Robo-advisors are essentially virtual financial advisors. Typically, there is a set of questions financial advisors will ask their clients at the beginning of the relationship. They’ll ask a client, what is your risk tolerance? What are your financial goals? Are you saving to pay a child’s college tuition, is there a down payment in the future you’ll need to save for? And so on.
A robo-advisor may be a digital platform and it begins the conversation the exact same way.
When you sign up for a robo-advisor, you’ll be asked all of the questions listed above. Then, it will use algorithm-driven financial planning services to set up a financial plan tailored to your needs and preferences.
So you may be wondering, if they do the same thing, why use a robo-advisor instead of a traditional financial advisor?
The benefits of robo-advisors
Both have their pros and cons but there are a few reasons robo-advisors have become popular over the past few years.
1. Cheaper than traditional advisors
A human being working as a financial planner may charge between 1-2% of a client’s assets under management, whereas robo-advisors typically charge between 0.2-0.5%. In many cases, robo-advisors use the same portfolio allocation software (created based on Modern Portfolio Theory) that a human financial advisor would. This makes robo-advisory a similar service at a fraction of the cost.
2. Faster than traditional advisors
Once you give the robo-advisor your preferences, it runs its algorithms and can have a customized portfolio built for you within minutes. Further, if a few years go by and your investing style changes, you can use the software to create a new plan instantly.
3. Accessible to everyone
Many established financial advisors only take on wealthy clients, i.e., a minimum of around £70,000 in assets. It’s not that they don’t want to help clients with less money, but because their salary depends on the total amount of assets they manage and they have limited hours in a day, it makes sense to target bigger fish. Robo-advisors don’t face this problem because they aren’t limited by mental bandwidth. So, there’s no need to require a minimum amount of total assets and robo-advisory services are accessible to everyone.
This is why growth the robo-advising industry has exploded over recent years and is projected to continue growing rapidly. It’s estimated that by 2025, there will be £2.16 trillion in assets worldwide that are managed by robo-advisors.
Although, professionals agree that it’s unlikely that robo-advisors will replace human advisors entirely. This is because robo-advisors have some inherent limitations.
Limitations of robo-advisors
1. Cannot provide emotional support
The study of behavioral finance has consistently found that people do not invest rationally. We know the market is cyclical, and recessions are temporary, but in the stress of the moment, we sell when the market dips. One of the biggest parts of a financial advisors job is to talk you off the ledge when the market crashes and you want to sell. They manage their clients temperament and prevent people from acting out of emotion. A robo-advisor is not a human being, and so it can’t do this nearly as effectively.
2. Struggle with complicated problems
A financial planner can help a client who recently had an unexpected medical bill, or received a large sum of inheritance. In their current state, robo-advisors cannot provide solutions to more involved, complex problems that clients may face.
Who should use a robo-advisor?
After looking at the pros and cons of robo-advisors, who should use one?
A study by Investopedia and The Financial Planning Association suggests that anyone can benefit from using a robo-advisor. The study found that, “there is a growing opportunity for automated investing platforms and financial planners/advisors to work together.”
The study surveyed participants across all demographics and the prevailing response was that both robo-advisory services and traditional financial advising were, “very satisfactory” in helping them achieve their financial goals. Although, participants felt that while both methods were effective, a combination of the two could be even more effective.
This means robo-advising shouldn’t be seen as competition for financial advisors, but rather as a way to augment their services.
Further, because of its accessibility, robo-advising has the potential to help guide millions of retail investors that would otherwise be operating in the dark. Rohit Kulkarni, an analyst at MKM, told CNBC, “approximately 60% of funded accounts on Robinhood were opened in the last 12 months, and a vast majority of them are first-time investors.”
These investors need guidance, and robo-advisors can provide it. The Investopedia study found 81% of respondents who use robo-advisory services said it helps support them and their financial plan.
In short, robo-advisory services can be combined with traditional services to help anyone, but they are especially beneficial for retail investors without access to a traditional advisor.
Looking to test out an investment robo-advisor?
If you’re new to investing and are looking for guidance on strategy, Stratiphy can help.
You can get an idea of how our app’s advisory tool works without committing to a payment plan by signing up to use our free tier. This package allows investors to create strategies, view European and US stocks, and create portfolios.
Our goal is to provide retail investors with the same investing strategies and techniques that ultra-wealthy investment banking clients have access to.
Important Information
All information provided is for information and education purposes, and this should not be read as investment advice. Stratiphy Limited does not take your specific needs, investment objectives or financial situation into consideration, and any investments mentioned may not be suitable for you. When you invest, your capital is at risk. The value of your portfolio can go down as well as up and you may get back less than you invest. Past performance is not a reliable indicator of future results. If you are unsure of any investment decision you should seek a professional financial advisor.