Is a Robo-Advisor Right for You? (2024)

Is a robo-advisor right for you? The answer is, it depends on your personal circ*mstances. This article will discuss the various factors to take into account to determine if a robo-advisor is the right choice for you.

Robo-advisors are automated investing services, which provide financial planning and investment services using computer algorithms. They can be found at many financial institutions such as Fidelity Institutional, Charles Schwab Corp., and others. In fact, nearly every financial company either has its own robo-advisor or is in partnership with one.

Is a Robo-Advisor Right for Me?

The first thing you need to think about is what level of advice and expertise you need to manage your money. If you have a seven-figure portfolio and need guidance in complex areas like tax planning, estate planning, the exercise of stock options, and the like, then a robo-advisor is probably not for you. Folks like this are better served by a relationship with a more traditional financial advisor.

For millennials and others with more modest portfolios who may need some asset allocation advice and perhaps a bit of basic financial planning help, a robo-advisor might fit the bill. Robo-advisors, for the most part, construct portfolios that follow passive strategies like indexing. They are relatively straightforward investment strategies that use ETFs to optimize a portfolio's risk versus expected return.

Beginners and those who prefer to just set it and forget it are most likely to appreciate the automation that robo-advisors bring. Because robo-advisors are low-cost and don't require sizable minimums to open an account, they are appealing to people who would not normally be able to afford a traditional financial advisor.

With a robo-advisor, you won't be able to pick individual stocks or trading strategies. Robo-advisors make all the decisions for you. So, if you're the type of person who may not have a ton of money to invest but want more control or autonomy in making investment choices, you may want to look instead to self-directed online trading platforms like Robinhood, E*Trade, or TD Ameritrade—all of which now offer free trading in most stocks and ETFs.

All Robo-Advisors Are Not the Same

Just as all traditional financial advisors are not the same, neither are all robo-advisors. In the world of traditional financial advisors, there are differences in their areas of expertise, how they are compensated, and the types of clients they work with. The same holds true in the robo-advisor space.

Robo advisors don't all come with the same features and price tags. Each robo-advisor may excel in particular areas. For example, one platform may focus on lower costs, whereas another may have the best app or offer more investment options. Some robo-advisors only allow broad-based index investing. Others are increasingly adding socially responsible portfolios for those clients who are conscious of those matters. Others, like M1 Finance, let users customize their portfolios.

Some robo-advisors may also cater to special groups of investors. For example, Ellevest advertises itself as a woman-run company designed for women.

These differences mean it's best not to just opt for the first robo-advisor you come across. You'll need to do some research into the best robo-advisors before you can choose the one that works for you.

Convenience and Accessibility

One of the major pluses of robo-advisors is the convenience of working with them and the ease of accessing their services.

Robo-advisors are accessible 24/7, which might appeal to a wide range of clients. With everyone's busy schedules, this level of accessibility might be attractive to some folks who need this level of accessibility.

At the same time, many robo-advisors are fully automated and only have limited human involvement. While some do have human advisors on staff to field calls and customer questions, most of these advisors are not actually working on your portfolios or investment choices—those are all done by the algorithms. Instead, these human interlocutors are there to keep your emotions in check and act more like a coach or therapist than a financial advisor.

How Investment Recommendations are Generated

Just because a robo-advisor is accessible and reasonably priced doesn't mean that the advice is good. It's incumbent upon anyone looking at using a robo-advisor to do their homework first and understand how investment recommendations are generated.

Most robo-advisors utilize algorithms of one sort or another in making their investment recommendations. While you might not be a mathematician or an investment expert, at the very least, ask questions and read up on their investment methodology to see if it makes sense to you.

The majority of robo-advisors follow investment strategies based on modern portfolio theory (MPT) in some form or another, and the best robo-advisor investment strategies can often be found by searching their website or from FINRA filings. MPT is a method of optimizing indexed portfolios by determining the best mix of asset class weights that generate the highest expected return for a particular amount of risk.

Hybrid Robo-Advisors

As more of the big players move into this space and competition rises, the quality and wealth of features offered by robo-advisors are improving.

Some of the best aspects of robo-advisors have began to overlap with the service offerings of traditional brick-and-mortar advisors such as online client portals on the websites of many financial advisors.

There are also Hybrid robo-advisors. This is a service that combines a robo-account with access to a human financial advisor. The client of a hybrid robo-advisor service is able to contact a live person either through a phone call or video conferencing. The live advisor can help with investment advice, planning and guidance, The client gets the advantages of the automated robo-advisor service and the live financial advisor service for a lower cost than if they had opted for a purely traditional financial advisor.

In the future, we may see more hybrid variations of the robo-advisor service by more traditional financial advisors to attract both younger and older clients. The idea behind it may be that these young investors will grow into more prominent clients who need, want, and can afford more traditional full-service advice, while the older clients who may or may not be computer savvy will be encouraged to use robo-advisors in some capacity if there is also a live person they can reach out to when required.

What Happens During Market Volatility?

When a market is volatile, it can be worrisome to some investors. Everyone reacts differently, from calling their financial advisor to changing their portfolios to leaving everything alone.

Robo-advisors, which do well as long-term investing tools, allow investors to choose portfolios based on a set of personalized financial goals, and the portfolios are rebalanced by investment professionals via the robo-advisor. When markets get volatile, emotions may run high. However, a robo-advisor makes disciplined decisions that are not emotionally driven. This lack of human involvement may cause the investor to experience an added layer of anxiety during volatile periods when markets are moving fast.

But if you can ignore market volatility, it was found that during the 2020 market downturn, for instance, robo-advisors held up in the face of a stressed market. According to research from financial advisors at Backend Benchmark, "many robo advisors with unique strategies or holdings performed better in terms of performance above/below the Normalized Benchmark."

A personal advisor who can talk to you about the market and your options may be a better bet for some nervous investors who need a more customized approach to their portfolios. Even though robo-advisors are designed to perform well during periods of market volatility, investors who nevertheless need personalized one-on-one service may feel better with a human advisor.

The Bottom Line