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When a robo-advisor is, or isn't, the right choice

  • It's important to understand that robo-advisors provide services, not financial planning, which is a critical component of financial success.
  • Robo-advisors don't necessarily protect against forgetting to contribute to investments, selling low or buying high, or panicking and making irrational decisions.
  • Working with a robo-advisor provides a low-cost solution to investors who are just getting started. Lower costs mean more money to invest.
Robot
Zapp2Photo | Getty Images

Whether you use Siri, rely on Alexa or have a Roomba, there's no escaping the fact that robots are part of our daily lives now. It's not a bad thing that we can automate some of life's most mundane, tedious tasks.

Did you know that you could also get robots to help you with your finances? Whether they look like Silicon Valley tech start-ups or they're owned by old-school, traditional financial firms, robo-advisors have joined the mainstream. They are an appealing investment solution, especially if you're new to investing and don't know where to start.

Before deciding to use an automated investment solution, you should consider if it's the best choice for you. Whether or not you are a beginning investor is one factor, but there are also other pros and cons of using a robo-advisor that depend on your unique situation and goals.

Automating the investing process

The investment strategies and portfolios robo-advisors offer are based on Modern Portfolio Theory and the Efficient Market Hypothesis. They use a process to determine exactly how to invest on your behalf. You sign up and take a short survey to provide answers to a few investment-related questions. The robot plugs your answers into an algorithm that determines the kind of portfolio and asset allocation that's appropriate for your age, risk tolerance and time horizon.

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You make your first contribution to your investment account, and the robo-advisor invests the money on your behalf. You can get started, but you don't have to worry about making complicated investment decisions or worrying about whether you're doing everything exactly right. This is perfect if you are not familiar with exchange-traded funds or mutual funds.

It's important to understand that robo-advisors provide services, not financial planning, which is a critical component of financial success.

Service, not guidance

Investment management and financial planning are both important, but they're not the same thing. Financial planning provides you with an actual human advisor who can educate and guide you to where you want to be with your money. This is an ongoing process that includes personalized attention and, importantly, accountability.

It's a long road to financial success, and having someone keep you on track can make all the difference. Services such as investment management from a robo-advisor provide you with options and solutions but little context.

Even though the process is mostly automated, it's still up to you to avoid doing things such as:

  • Forgetting to contribute to your investments.
  • Not increasing your contributions over time.
  • Selling low or buying high.
  • Panicking and making irrational investment decisions (like drawing out all your money at the bottom of the market, which can destroy your wealth).

A student can sign up for any class offered by the local college, because that's a service the college provides. But to make the most of their educational experience, that student also seeks the advice of an academic advisor. The student uses the guidance, advice and accountability of the academic advisor to choose the appropriate courses for them. As a result, they achieve their goal of graduating on time and they were able to rely on their advisor when they were making tough decisions. Financial planning can provide you with similar benefits as you invest and build wealth.

Weighing the pros and cons

Robo-advisors provide benefits to specific kinds of investors with a certain set of needs. Working with a robo-advisor provides a low-cost solution to investors who are just getting started. Lower costs mean more money to invest. The fees from robos can be less than human advisors, although this difference can be less than you think. Robo-advisors can't take your long-term lifestyle goals into account and a successful investment strategy always aligns with those goals.

Fees are also low because robos typically invest in index funds and ETFs. But you can also easily do this on your own if you choose. Most robos use solutions such as Vanguard's funds and ETFs, which are available to the public without having to pay the robo-advisor fee that is added on top to the underlying mutual fund or ETF fees. When weighing that value, you should take into consideration the automated rebalancing and tax-loss harvesting most robos provide.

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Even Vanguard requires you to have a few thousand dollars to invest with them. Robos can require as little as $0 to open an account. This enables younger investors to build wealth earlier, which is critical when time and compounding interest are your greatest advantages to increasing your nest egg.

Getting started is fast and simple. Create a username and password, answer a few questions and you have an investment account. Robos offer one of the simplest, fastest ways to go from saver to investor. From there, you can automate deposits and create a variety of investment accounts.

Other considerations

Remember, you can always pick up the phone and talk to your financial advisor. The value of a two-sided conversation is worth its weight in gold. While some robos offer "customer service," your call goes to a call center. An advisor might be at the other end, but they won't be your advisor you have a relationship with.

Along those same lines, an advisor can provide insight that a robo can't. Emotions can cloud the judgment of even the most battle-tested investor. The urge to sell during a downturn or chase after underperforming stocks is human nature and can be hard to fight on your own. A human advisor can help clients balance emotions with practical advice and judgment.

"Robo-advisors provide an excellent starting point to building wealth. Financial advisors provide the options, accountability, experience and nuance to reach your goals."

Robo-advisors offer simplicity, but simple isn't always the best approach. Lifetime goals and plans can't always be determined by a few questions and answers. While robo-advising takes away the need for expertise, it also takes away important context and subtle nuances. A robo's reasons for choosing a portfolio can be completely different than an investor's.

When to choose a robo-advisor

Robo-advisors are a great option for entry-level investors because of their low fees, low cost threshold and ease of use. If you have $25,000 or less to invest, robo-advisors may be a great option to help you get started. Investing for the long term and growing your wealth beyond this level, however, requires the experience and guidance of a qualified financial and investment advisor.

Financial advisors provide customized, holistic solutions and they can also offer investment options not available on robo-platforms. A strategic approach that goes beyond index funds is important if you want to build your wealth beyond the low six figures. And human advisors can adapt to life's curve balls in a way that even the best artificial intelligence can't manage just yet. Robo-advisors provide an excellent starting point to building wealth. Financial advisors provide the options, accountability, experience and nuance to reach your goals.

(Editor's Note: This column originally appeared on Investopedia.com.)

— By Eric Jansen, founder, president and chief investment officer of AspenCross Wealth Management

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