If you have a few hundred bucks you're not quite sure what to do with each month, a robo advisor might be the answer.
As a young adult, your financial goals probably seem straightforward: cover your rent (with the hope of ditching roommates in the near future); pay your bills and high-interest debt; afford dinners out with friends or your significant other; save for a vacation at least once a year; and contribute to your 401(k). Once you're a bit more comfortable, you might start thinking about saving for a down payment or padding your rainy-day fund. What often gets left out? An investment portfolio.
The finance industry has long been male-dominated, and for many reasons, there is an investment gender gap. But with the rise of websites that make investing easy (often called robo advisors), investing is becoming more democratized. People historically left out now have access to tools previously available only to the wealthy. So if you have a few hundred bucks you're not quite sure what to do with each month, a robo advisor might be the answer. Thanks to this new technology, anyone can be an investment genius.
What Is Robo Advising?
A robo advisor is an online investment and money management tool that relies on minimal human intervention. It gives consumers direct access to portfolio-management technology used by financial professionals. Unlike traditional human financial planners or money managers, robo advisors minimize fees, and you don't need a ton of money to access their services. Traditional advisors also typically require a large minimum balance for added benefits like tax optimization on investments. Many robo advisors do not. Robo advisors mostly focus on portfolio management and not tax fillings or estate planning, although they are expanding their services.
Robo advisors make it easy to invest in relatively safe and cheap investment vehicles.
Most money invested with robo advisors is directed toward exchange-traded funds (ETFs). These are funds that typically track an index (like the S&P 500), which means your investment is more diversified than if you picked individual stocks. ETFs also have lower fees than mutual funds. Basically, robo advisors make it easy to invest in relatively safe and cheap investment vehicles (ETFs) that don't require much thought once you're in.
There has been a rise in robo advising since 2008. Popular robo advisors you may have heard of include Wealthfront, Betterment, WiseBanyan, Schwab Intelligent Portfolios, and Ellevest. Before you choose one, review the pros and cons of each for your specific situation. NerdWallet has a great breakdown.
How It Works
While each service is different, setting up a robo advising account follows a similar pattern. You will fill out an online survey that will assess your financial goals and how much risk you're comfortable with. You will then add some money to a trading account. Then, the robo advisor will buy a portfolio based on your stated risk level and goals. As you gain and lose over time, your portfolio will be automatically balanced to maintain the initial plan. You can also set up automatic deductions from your checking account to ensure you continue to invest consistently. This also allows you to buy when the market is both high and low. Using the robo advisor's website or app, you're able to easily check in on your performance as you go.
Time is on your side: Investing in a diversified stock portfolio will help you turn those few hundred dollars you set aside each month into much more. Letting it sit in your savings account deprives you of the benefit of time. And time is investing's best friend, according to Nick Holeman, a certified financial planner and financial planning expert at Betterment. Holeman points to research to back up his point: "Someone who puts $4,000 per year into retirement accounts starting at 22 years old can have $1 million by age 62, assuming eight percent average annual returns. Wait 10 years to start contributing and you'd have to put in more than twice as much - $8,800 per year - to reach the same goal." To put yourself ahead, he says you should save as much as you can while you have fewer demands on your income, like kids in college.
"You will not get rich quick from picking a winning stock, nor will your advisor get you rich quick."
They use a passive investment strategy: Robo advisors are built on principles of passive investment. A passive investment strategy avoids frequent trading in order to reduce fees and improve long-term performance. Passive investing assumes the general market will go up overtime and focuses on steady growth vs. quick gains. In other words, it believes you're better off sticking your money in a diversified set of stocks and leaving it alone.
Wealthfront's chief investment officer is renowned economist Dr. Burton Malkiel, author of A Random Walk Down Wall Street. Malkiel popularized the idea of investments tied to index funds. "Dr. Malkiel has spent his life's work trying to get consumers to understand that unless you have billions of dollars, the chances of you accessing services that will beat the market for you are zero," explains Kate Wauck, head of communication for Wealthfront. "You will not get rich quick from picking a winning stock, nor will your advisor get you rich quick. Decades of data now prove this. What you can do is keep fees low, buy and hold a diversified portfolio of ETFs, and be smart about taxes."
You can access the money: Unlike a tax-deferred 401(k) or IRA, there are no tax penalties for accessing money in a taxable account you set up with a robo advisor. Once you've set aside money for expenses coming up in the next year and maxed out your retirement contribution, robo advisors will help you grow the pot of money available for midterm expenses you expect a few years down the road. You get the benefit of time without having to wait until you're retired to enjoy it.
They minimize fees: You can never perfectly guess what the stock market will do. But you can be certain that high fees will lower your return. A traditional financial planner might charge you a one percent fee, while robo advisors often charge a quarter of that. (Some even offer no fees for the first $10,000.) In addition, choosing ETFs over mutual funds reduces fees.
It's easy: Wauck says most Wealthfront clients sign up because they can manage their investments and financial planning through the palm of their hand. "Our clients can get answers to life's big financial questions any time, anywhere, and don't have to wait for that awkward meeting with an advisor."
The Growing Trend
A 2016 study from KPMG found that 80 percent of millennials are likely to consider robo advising. This new generation, which is used to the instant ease of the internet, appreciates the online interface and that money is automatically invested. Services like Wealthfront and Betterment have seen a rise in demand for their products, something the KPMG study predicted. Betterment has grown 300 percent year-over-year, while Wealthfront has over 100,000 clients. It's easy to see why, since these robo advisors give people with $500 the same tools previously reserved for those with $5 million.