Want to get started in the world of investing, but not sure about picking your own stocks and managing your own portfolio? A robo-advisor can do all of this for you.
A robo-advisor is a digital platform that uses computer algorithms to build and manage a diversified portfolio based on your risk tolerance, financial goals, and other personal factors. It also automatically rebalances your portfolio based on market conditions and your investment goals. Although it sounds interesting, a robo-advisor can pose big risks. Before investing, you need to weigh the pros and cons.
The benefits of a robo-advisor
Robo-advisors continue to grow in popularity. According to a study by international consultancy Deloitte, assets managed with the support of robo-advisors could reach more than $16 trillion by 2025, around three times that of BlackRock, the largest asset manager in the world. world. Indeed, robo-advisors can offer several features that would appeal to investors looking for a hands-off, hassle-free approach.
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Costs: A human financial advisor may charge an Assets Under Management (AUM) fee of 1% or more. Robo-advisor AUM fees can range from 0% to 0.40%. To put that into perspective, a 1% AUM annual fee on a $10,000 investment comes out to $100. A 0.25% AUM fee on a $10,000 investment is only $25 per year.
Diversification: Most robo-advisors provide you with a questionnaire about your financial goals, risk tolerance, etc. An algorithm uses these answers to recommend a combination of investments.
Automatic rebalancing: Market conditions can shake up your investment mix and leave you too focused on one asset class, putting you at major risk in the event of a downturn. When this happens, robo-advisors rebalance your portfolio back to its original investment mix, sometimes selling investments that have gone up and using the proceeds to buy those that have fallen.
Disadvantages of robo-advisors
Despite the hype, robo-advisors have their potential downsides:
Hidden costs: Even though robo-advisors generally charge much lower management fees than traditional advisors, your money is still eaten up by the expense ratios or fees charged by the funds in your portfolio. Some would say you can just open a discount brokerage account and invest in these funds yourself, avoiding AUM fees altogether. There are many online asset allocation tools that can recommend a personalized investment mix, similar to how a robo-advisor uses a questionnaire.
Fluctuating fees: Some robo-advisors may increase their AUM fees as your balance increases. The more you invest with them, the bigger the cut they take.
Little or no human interaction: If you have a premium plan or pay extra, some robo-advisors give you access to financial planners that can help you achieve other financial goals, like paying off high-interest debt. . But many plans offer no access to human advisors. For those looking for a hybrid service that lets you speak to a human advisor whenever you want, your options may be limited.
Is a robo-advisor right for me?
If you are comfortable entrusting investment management to an advanced algorithm and professionals, accepting limited investment options in exchange for potentially low fees, then a robo-advisor may be right for you.
But if you have experience or have some time to develop your investment acumen, it may be best to create and manage your own portfolio.
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Foolish contributor Javier Simon holds no financial positions in the companies mentioned. The Motley Fool has a disclosure policy.