HERE COME THE ROBOS
If you’ve googled anytime recently something like “how to start investing” or “how do I open a Roth IRA”, you’ve probably heard of investment companies that are being dubbed “robo-advisors.”
The term “robo-advisors” refers to a new generation of online investment companies that make it extremely easy to open investment accounts and get a widely diversified portfolio using sleeker, smarter technology. They even do a basic assessment of your risk tolerance, time horizon, and goals to recommend an asset allocation for you. Because of their economies of scale and high-quality automated systems, they’re also able to provide services like rebalancing, tax-loss harvesting, and fractional share purchases quickly and efficiently - much faster than any human professional can. Most of all, they do all of this for a very low cost.
HUMANS VS. ROBOTS
In the past, people have traditionally paid an investment advisor a 1 to 1.25% annual fee on their assets to receive these kinds of investment management services.
But now, it’s possible for a person to get similar - but not necessarily the same quality - services for 0.5% or less through a robo-advisor. Consequently, robo-advisors have caused a kind of “disruption” in the investment advising industry!
So are they enough to replace a human advisor?
Traditional (and by that I mean human) advisors are claiming that the automated processes of robo-advisors can only give you cold, canned, templated advice that could never be as good as the personalized direction you’d get from working with a living, breathing, competent human financial advisor (for the record, I do believe that’s true).
Meanwhile, robo-advisors are leveraging technology to create an awesome user experience and invest your money for you in an efficient and (dare I say it?) fun way. And for the most part, they advertise themselves as a cheaper alternative to human advisors.
So if you’re a young investor looking for help reaching your financial goals, where do you turn?
UNDERSTANDING THE DIFFERENCES
If you frame your question as “should I open/rollover an IRA at a robo-advisor or through a financial advisor?”, you’re not comparing apples to apples. The notion that investment advice and financial planning are synonymous needs to be hewn down. They're not the same thing. I know they’re often used interchangeably, but it’s done so inaccurately. Let me explain it briefly.
Investment advice, at its most basic level, answers the following question: “I have a financial goal; how much should I save and what should I invest in to reach it?” This is something that robo-advisors can now do a pretty fine job of calculating for you. Just drop in your money like a bank account, and they take care of the whole investment part.
But financial planning is so much more than that! It digs into these questions: “What do you want that future money for? Why do you want that? Are your current financial choices in line with your values? Is your financial goal realistic or feasible for you?"
It doesn’t stop there. Good financial planning is comprehensive and will seek to strategically integrate all areas of your finances, helping you balance several goals at once:
- Do you have debt you need to pay off?
- Do you have adequate emergency reserves?
- Are you planning on starting a family?
- What does your tax situation look like? Is your estate properly set in order?
- Are you diversified outside the public markets, like in your own business or local real estate?
Those are all questions a robo-advisor can’t help you with. Investment advice for your account with them, based on limited information, is all they can offer. Investment selection is a critical part of your financial plan, but it’s still just one part. Are you even ready to invest? Should you be using a Traditional or Roth IRA? How much should you invest right now in light of the other goals you have?
ASSET ACCUMULATION > ASSET ALLOCATION
When I started Wealth Mode Financial Planning, I had to make the decision of how to invest my client’s assets. This was difficult decision. After all, when people hire a financial advisor the first thing they usually expect to receive - perhaps more than anything else - is advice about what to invest in.
The tempting thing to do was try to justify my professional background and training and say that I needed to build a unique portfolio for each individual client.
However, I personally don't believe you can "beat the market" on a consistent basis, and my investment philosophy relies mostly on passive, globally-diversified indexing. And robo-advisors can do that fairly well - not perfectly, but pretty well.
The tipping point was in recognizing something vitally important. I knew that I wanted to work for my peers - those in the first 10-15 years of their working careers. And when you’re younger, asset accumulation is more important than asset allocation.
What do I mean by that? People really get hung up on their asset allocation and what they're invested in, at the expense of making good financial decisions all-around. While your investment portfolio is extremely important and needs to be set up right, there is no perfect allocation or single investment that is going to make up for not saving enough. You have got to save and invest money as early and as consistently as possible - and with good financial planning, you can learn a lot of unique ways to do that through cash-flow decisions, tax savings, and more.
As you accumulate a significant amount of investments and get older, it may become more important for you to craft an allocation and portfolio very unique to you. Other factors like risk tolerance, tax placement, and distribution timing become more crucial.
But right now, the most important thing is to invest in your human capital, make smart choices in all areas of your financial life, ramp up your savings, and accumulate, accumulate, accumulate.
HUMAN PLANNER CHOOSES ROBO-ADVISOR
Back to my decision. Just how would I invest my client’s assets at Wealth Mode Financial Planning?
Luckily, there was one robo-advisor in particular that created a perfect solution: Betterment.
Betterment is perhaps the most popular robo-advisor in terms of media coverage, consumer reputation, and number of clients. In my opinion, they do the best job of taking a behavioral approach to encouraging you to reach your financial goals. They also have a sound, research-based philosophy in their investment selection. In fact, I had been a proud user of Betterment for several years before starting Wealth Mode Financial Planning - I opened my first Roth IRA with them when I was a sophomore in college, so know that I put my money where my mouth is. They do a great job.
But, they're not perfect. A robo-advisor can never match the comprehensive financial guidance you can get from a human planner.
THE BEST OF BOTH WORLDS
A couple years ago, Betterment introduced a way for clients to get the best of both worlds. They teamed up with human advisors. People can now access the low-cost investing experience of Betterment with the holistic financial advice of an actual financial planner. In addition to that, some investment options that aren't available to people in a regular Betterment account are now available if you go through an advisor.
When I craft a financial plan for a client and they need to open an IRA, rollover a 401(k), or invest in a taxable account, they can open a Betterment account through Wealth Mode Financial Planning. This allows me to keep a close watch on how their investments are doing in the broader context of their overall financial plan to live in Wealth Mode.
So if you’ve always thought that the choice is between using a robo-advisor or a human advisor to begin (or continue) investing, realize that it’s not one or the other.
You can have both. Just remember: only one can actually give you a complete financial plan and real financial advice.