Financial advisors fall into two categories in the 21st century: “robo” and human advisors. The main difference between the two is the presence. One type of advisor is an often well-paid financial expert, whom you can meet one-on-one. The other is electronic, using algorithmic trading tools, mobile apps, and digital signatures to help you invest your money.
In 20210, Betterment launched one of the world’s first robo-advisor to serve ordinary individuals who did not have enough assets to interest a skilled financial advisor, many of whom still require an account minimum of five- to six figures and who charge 1% or more each year in assets under management (AUM).
The solution to finding affordable financial advisement was to take advantage of advances in both technology and market structure to offer low-cost and effective investing with extremely low opening balances via a “robo-advisor.”
ETF trading has become commission-free at several brokers and clearing firms and adds up to robo-advisors managing client money for little to no fee charges.
Financial advisors are often more than investment managers–they are communicators, educators, planners, and coaches to their clients.
Some traditional advisors now offer robo-advisors-as-a-service as part of the portfolio construction and investment monitoring side of a more holistic financial planning practice.
Aside from the low cost and ease of opening an account, robo-advisors also have several advantages due to their heavy reliance on technology. The first is that robo-advisors can automate investing strategies, such as modern portfolio theory (MPT), that optimize the ideal asset class weights in a portfolio for a given risk preference. These calculations, while doable by hand, are laborious and prone to human error. A machine, on the other hand, can optimize thousands of portfolios in an instant without mistake. Moreover, algorithms can monitor and rebalance the same thousands of portfolios in real-time when markets move, and asset class weights need to be adjusted.
The same algorithmic “eye” can also provide real-time tax-loss harvesting, a tax minimization strategy that sells securities that have lost money in the market and replace them with similar assets. By doing that the overall portfolio structure is about the same as before, but the capital losses incurred can be used to offset capital gains elsewhere.
Perhaps the most significant benefit of a robo-advisor is that it is truly set-it-and-forget-it. Many people don’t like to think about finances and dread their semiannual phone call with their financial advisors. Other people who are DIY-inclined trying to build their portfolios often don’t have the time, discipline, or skill to do it “right.” Leaving it to the algorithms can lead to a less stressful financial life.
For younger investors who may not have a lot of money to put into the markets, the low-cost and technology advantages of robo-advisors can be attractive. As digital natives, perhaps the lack of human interaction is prized rather than admonished.
Before algorithms like these, tax-loss harvesting was time-consuming and tricky since a mistake could result in an illegal wash trade.
Of course, the main thing that is lost with a robo-advisor is the human element. Financial advisors are often more than investment managers–they are communicators, educators, planners, and coaches to their clients. Relationship-building is a core part of any financial advisor’s business and is often extremely important to their clients. A robo-advisor, for all the fees that it saves you, will never show up at your son’s baseball game, take you out to lunch, or send a condolence card.
With a robo-advisor, account opening often involves a quick risk-profiling questionnaire and inputting some personal information. Instead, a traditional financial advisor typically begins with a personal meeting between client and advisor, with the advisor’s goal of getting to know you.
The advisor looks to understand why you’re investing and tries to grasp your short-, medium-, and long-range goals. The advisor learns your risk tolerance, helps you set goals, and develops a personalized plan. The advisor then recommends investments and tactics that they hope to fit with your goals.
Being on-call to answer questions, provide personalized advice, and capture a broad swath of knowledge–from investments to tax and estate planning to insurance–is a valuable resource. However, this human touch comes with extra cost, but it’s a cost that many people find valuable and are willing to pay for. For older, wealthier, or technology-averse investors, a financial advisor will provide more personalized service, a greater breadth of financial advice, and a real person-to-person relationship in many cases.
On the technology side, the use of algorithmic trading, mobile apps, and digital signatures mean that the account-opening process no longer required reams of paperwork to be signed. In addition, it means that computers can execute trades without error and monitor portfolios continuously–something that financial advisors could never be able to do for more than a handful of accounts at a time.
And several robo-advisors now do have financial advisors on-call to answer questions and provide assurances. However, unlike traditional financial advisors, many of the financial advisors hired by robo-advisors cannot make specific investment recommendations or alter the client’s portfolio weights because the algorithm governs those.
On the other end of things, traditional advisors now offer robo-advisors-as-a-service as part of the portfolio construction and investment monitoring side of a more holistic financial planning practice. These tools are often white-labeled offerings from robo-advisor providers, such as Betterment or E*Trade, geared specifically toward advisors.
Although financial advisors are more expensive and require larger starting amounts, and even though humans are prone to mistakes and implicit biases and errors, those costs and even those fallibilities can provide both value and solace. In the end, perhaps a hybrid approach is best–combining desirable aspects from each.