Beginner's Guide to Robo Advisors

Estimated read time: 5 minutes

Finding trusted and secure financial planning services is critical to your financial well-being. This brings with it a lot of research, discussion with experts, and time spent debating the merits of one advisor compared to another. This can feel overwhelming. Financial advisors can seem intrusive, too competitive, and treat you as just another statistic on their path to market dominance.

That's where robo advisors come in.

Though you may speculate about robots taking over the world, there is credibility in using robo advisors for financial planning. They use trusted algorithms backed by constantly updated data to implement strategies tailored to your individual needs. That is because your financial journey is personal.

What are Robo Advisors?

Robo advisors are digital constructions that provide a wide range of financial planning services, from general budgeting to financial advice and investment strategies. They are automated and based off algorithms, providing minimal interactions with humans.

Individuals seeking to utilize robo-advisors will need to provide personal information regarding their current financial portfolio, where they would like to be, and what financial strategies they would like pursued. Clients are able to select between low risk or high risk preferences and can continually update their profile as time passes.

Robo advisors provide wealth management services across a range of investment options. These include stocks, bonds, real estate, futures, and ETF portfolios. Though you can specify which option(s) you would like to pursue, robo advisors often prefer ETF portfolios due to their return and ability to better utilize algorithms.

By taking emotion and "feel" out of a financial decision, robo advisors rely solely on data and mathematics to drive results. This provides greater security to those who may question the motivations of human financial service providers.

Robo Advisors: A Brief History

In the midst of an emerging financial crisis, Jon Stein had a bold idea. He sought to automate the process of wealth management services in order to bring about trusted results at lower barriers to entry. So, in 2008, Betterment was launched. Its initial pitch was that of offering an investment strategy based on target goals (often referred to as target-date fund).

By taking advantage of the growing online marketplace and software services, the first robo advisors emerged and hit the market fast. They offered simple, navigable interfaces and low barriers to entry. No longer did one have to be part of a wealth management firm to use automated programming in financial management.

The emergence of robo advisors forwarded the trend of cutting out the middleman. Financial advisors and wealth managers were always the ones with access to automated programs. By cutting them out of the equation, the first robo advisors were able to offer the same services at reduced costs. The operational overhead was much lower, and in the midst of the Great Recession it is easy to see why they grew in popularity.

Since their original debut in 2008, there are now more than 100 companies offering robo advisors to the public, and these numbers are only expected to grow as more offer college savings, retirement planning, and additional services.

Pros and Cons of Going Robo

There is not much difference between the algorithms and programming methods used by robo-advisors and that of their human counterparts. Both have access to trusted mathematical solutions when it comes to wealth management.

The main benefit of using a robo advisor having direct access to wealth management algorithms and programs at low costs. Annual flat fees are minimal and based on total account balance. Traditional financial planners often charge in the same way but do so at higher percentage rates. This is to cover their individual living costs and business overhead.

Another benefit to consider is that of accessibility. Robo advisors do not sleep, eat, or need to take time off. Even the best and hardest-working human financial planners do. Robo advisors give you unprecedented access to wealth management services. 24/7 accessibility means you can update your profile and goals whenever the needs arise. There's no waiting on hold or for business hours to open up. This allows you to act as quickly as possible to sudden market changes.

With its low entry cost also comes another advantage. Many companies offering robo advisors do so with lower minimum account balances than traditional wealth management firms. Whereas human advisors can often require an individual to have at least $100,000 invested, robo-advisors offer minimal account balance requirements.

The main significant drawback to robo advisors is they do not offer the same personal feel many are used to. The abandonment of human interaction can be difficult for some. This is compounded especially if you are not one inclined to trust automated programming or see robots and computers as taking over the world. By taking emotion of the picture you are also sacrificing the "gut instinct" that some financial advisors carry. That means minimizing risk but sometimes missing out on big opportunities.

Best Robo Advisors for Beginners

With more than 100 companies offering robo advisors to the public, it can be difficult to sort through which one is best. By exploring a variety of them you open your financial portfolio to increasingly personal and unique options.

Think of choosing a robo advisor as you would weigh any other financial decision. You must consider who you are, where you stand financially, and where you want to be. Take, for example, a business owner considering a credit card. You are not going to just pick the first one you come across. You will weigh the options carefully and come to a calculated decision. Employ the same decision-making process when considering a robo advisor.

The top companies to look into are Betterment, Wealthfront, Personal Capital, The Vanguard Group, and the Charles Schwab Corporation. These companies are the ones with the largest assets under management (AUM) and thus have a broader set of tools and trusted results.

While The Vanguard Group and Charles Schwab Corporation are in a class of their own (due to account minimums and accessible services), deciding between Betterment, Wealthfront, and Personal Capital often boils down to individual preference.

Account minimums and fees for each of these three services are as such:

  • Betterment – No minimum (0.25% OR 0.50% account balance fee)
  • Wealthfront – $500 account minimum (0.35% account balance fee)
  • Personal Capital – $25,000 account minimum (0.49% – 0.89% account balance fee)

As you can see, Personal Capital is somewhat of a bridge between the offerings of Betterment and Wealthfront and the larger Vanguard Group and Charles Schwab. Like the other two large robo advisors, Personal Capital includes a personal financial advisor and tiered services. If you have experience in financial management and the assets to cover account minimums, you may be better-suited for services offered through a larger entity.

If you are just exploring robo advisors and don't have $25,000 in investable assets, Wealthfront or Betterment is the option for you. These are the most robust and results-backed companies out there offering this service.