By now, robo advisors are practically ubiquitous. You can't go anywhere on the financial internet without seeing an ad for a robo advisor.
Indeed, robo advisors have played a role in making investing more accessible to more people.
However, before you decide that a robo advisor, rather than a human financial advisor, is the right decision for your own investments, you need to review your needs and decide if the whole thing makes sense for your own investing style.
Here are some things an investor should consider:
-- Advantages of a robo advisor.
-- Downsides to a robo advisor.
-- Taking a hybrid approach to robo advisors.
Advantages of a Robo Advisor
Robo advisors are designed to make investing easy.
Using algorithms based on modern portfolio theory, many robo advisors automatically decide how to divvy up your portfolio. This process is called asset allocation, and it's based on your long-term goals and risk tolerance.
Rather than focusing on picking individual investments, the idea is to use exchange-traded funds, or ETFs, in certain asset classes to put together a portfolio.
This approach works well for those who are more hands-off in their investing, and also can result in a lower cost to the investor thanks to low fees compared with those charged by a financial advisor.
If you have a long-term goal, you might not be worried about market-beating performance. Instead, you're more concerned about building your portfolio over time with the help of various stock-based ETFs.
As you approach your goal, and depending on your risk tolerance, your portfolio might shift to focus more on bond funds.
A robo advisor makes all of this easy, based on a few questions you answer when you set up your account. You can review your asset allocation regularly and make adjustments.
Overall, though, the idea is to set it up and then largely forget about it. As long as you make regular contributions to the account, you should, theoretically, see your portfolio grow.
On top of all this, robo advisors are easy to access.
In many cases, this is a low-cost way to invest. Often there is no minimum investment to open an account, and you can start investing with a relatively small account balance. In fact, you can set up automatic transfers to your investment account fairly easily, and the robo advisor will take whatever you send and automatically invest it according to the way you prefer your assets divided up.
Downsides to a Robo Advisor
While a robo advisor can be great for a beginner or someone who takes a more passive approach to investing, it might not be the best choice for you.
One of the biggest downsides to using a robo advisor is that you're not totally in charge. Instead, the algorithm decides how to invest your money.
You might be able to tweak your overall asset allocation or choose from options like socially responsible investing, but you don't have a lot of choice in exactly which investments are used to create your portfolio.
Another issue is that you likely can't engage in trading on your own terms. You usually don't have access to individual stocks or bonds on a robo advisor platform. If you're interested in trading, a robo advisor isn't going to work for you.
Finally, if you want to execute quick trades in a volatile market, a robo advisor won't work for you. Robo advisors are generally set up for a buy-and-hold approach.
Taking a Hybrid Approach to Robo Advisors
Of course, using a robo advisor doesn't have to be all or nothing. You can use a robo advisor to take a hybrid approach to your portfolio.
Because robo advisors are ideal for those who take a long-term approach to portfolio building, it can work well to keep your retirement account with a low-cost robo advisor.
If you've changed jobs and decide to roll your 401(k) into an individual retirement account, a robo advisor can be a solid place to keep that new IRA. Other medium- to long-term goals can benefit from the robo advisor approach.
However, you don't need to keep all your investments with a robo advisor. Once you have your long-term accounts set up to automatically grow with a robo advisor, you can take some of your other money elsewhere.
If you're interested in making trades or trying to beat the market with a portion of your portfolio, or if you want to be able to buy specific stocks on a dip, you can keep some of your money in a trading account that lets you execute more quickly.
There's nothing wrong with dividing up your portfolio in a way that makes sense for you -- and ultimately helps you reach your goals. A financial planner can help.
For the most part, computerized financial advisors work best for long-term strategies designed around asset allocation.
As long as you consistently contribute, there's a good chance your portfolio will grow over time and you can adjust the overall strategy as needed. In addition, this low-cost approach can mean your portfolio would benefit from low fees.
On the other hand, for money that you want more control over and for individual stock investments, you might want to maintain a trading account and consider hiring a human advisor.
A hybrid approach also will enable you to deploy tax-loss harvesting for underperforming stocks.
That way, you can make your own moves -- at least with a portion of your portfolio.
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