Pros and Cons of Robo-Advisors - What You Need to Know

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Nov 16, 2024

Pros and Cons of Robo-Advisors - What You Need to Know

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A robo-advisor can help you automate investing for any financial goal — be it retirement, college savings, emergency fund building, or wealth accumulation. A robo-advisor is a software algorithm, and its concept is pretty simple. However, many people are still on the fence about entrusting this software with their investments. If you are among those who are cautious and unfamiliar with robo-advisors, this article is a perfect place to be. We’ll now go through the pros and cons of robo-advisors to help you make informed decisions.

In this article

What are robo-advisors, and how do they work?

Many people want to invest but have no idea where to begin or — more often — lack the necessary time. Investing can be quite time-consuming, especially for beginners. That is why robo-advisors are excellent online investment guides. A robo-advisor is a digital platform (specifically an investment brokerage account) that automates the process of investing. As such, the robo-advisor platform replaces human financial planners.

This platform asks a bunch of questions about your current financial situation and future goals and uses that info to create a perfect financial strategy for you to help you reach those goals. Based on that strategy, the robo-advisor advises you and automatically invests on your behalf. What’s important is that robo-advisors will always have your best interest in mind when investing.

Aside from having low fees, top robo-advisors can provide services such as easy account setup, detailed financial goal planning, account and portfolio management, and security features. In addition, they offer in-depth education. You can choose between these two types of accounts from robo-advisors — tax-advantaged individual retirement accounts (IRAs) and taxable brokerage accounts.

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The pros of using robo-advisors

Robo-advisors have many advantages. This is especially true for investors who invest with less money and beginners who are still gathering knowledge about investing. Robo-advisors allow you to create smaller portfolios without having to deal with pushy human advisors who are in a hurry to close the commission. Here are the positives of using robo-advisors:

Low fees

Robo-advisors charge lower fees than traditional human financial advisors. Most platforms use low-cost exchange-traded funds (ETFs) to create pre-built portfolios. That means that you keep more of your investment returns.

Robo-advisors typically take anywhere from 0.25% to 0.50% in fees (from the total investment amount). However, if you choose human advisors, prepare for higher fees, usually between 0.5% and 1.5% of your investment. If a robo-advisor manages $10,000 at a 0.25% rate, it would cost just $25 annually. On the other hand, if the traditional advisor manages the same $10,000 investment at a rate of 1%, it would cost $100 per year. This fee difference clearly shows how much you can save using a robo-advisor, especially for smaller investments.

Accessibility

Robo-advisors are easily accessible from anywhere. This encourages anyone to start investing. You can easily manage your account via mobile app or online.

Ease of use

You do not need much investment experience to get started with a robo-advisor. They greatly support beginners by guiding them and making investment decisions based on previously defined financial goals and individual risk tolerance.

Automated portfolio management

Using a robo-advisor, you can invest hands-free. The platform automatically rebalances your portfolio and makes adjustments if necessary. When you invest money in specific funds with a robo-advisor, you know someone is looking after everything, so you can focus on other aspects of your life without having to monitor your portfolio constantly.

Tax efficiency

Tax efficiency means finding ways to pay less tax on your investment profits. Many robo-advisors use a method called "tax-loss harvesting" to help with this. Here is how it works: a robo-advisor sells investments that have lost value, which creates a loss you can use to lower the tax for your other profitable investments. This way, you keep more earnings and spend less on taxes.

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The cons of using robo-advisors

Like everything, robo-advisors come with some drawbacks that can deter some people from using this software to invest.

Limited personalization

Robo-advisors often do not provide personalized advice for complex financial needs. While they allow you to set and customize goals using their software, they do not consider your unique financial situation. You will benefit more from speaking with a human advisor if you have specific concerns or questions. After all, a real human being will always understand your needs better than an algorithm.

Basic investment options

Robo-advisors typically focus on limited investment options, mostly ETFs and simple portfolios. If you have bigger ambitions and want to invest in individual stocks or use more advanced, sophisticated strategies, robo-advisors may not be for you.

Reliance on algorithms

The algorithms robo-advisors use excel at automating trading and portfolio management but lack human insight and understanding of market dynamics. This can sometimes result in decisions that do not consider your specific financial needs.

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Who should consider using robo-advisors?

Robo-advisors can be an excellent choice for new investors, busy individuals who want to manage their investments without committing too much time, and those who want to pay lower fees. Robo-advisors provide user-friendly platforms to help you overcome the intimidation factor when investing.

Who should avoid robo-advisors?

Robo-advisors are not the best solution for everyone. Investors with complex financial needs may find that a robo-advisor lacks personalized advice. Yes, robo-advisors benefit many people, but those with bigger needs and a desire for personal engagement should use a traditional human approach.

Robo-advisors vs. traditional financial advisors

There are visible differences between robo-advisors and traditional financial advisors in terms of their approach, fees, personalization, and services. A robo-advisor is a good choice if you want straightforward, low-maintenance investment management.

However, a traditional advisor may be better if you need personalized advice, tax strategies, one-on-one guidance, or in-depth support, though such services come at a higher cost.

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