Historically, consumers have had two options when it comes to investing: do the hard work themselves of finding companies or industries to invest in, or hire a financial advisor to do it for them. In 2013 that changed when Jemstep, a subsidiary of Invesco created an automated portfolio manager designed to help consumers allocate their investments into a portfolio that fits their risk profile while providing detailed analytics to help consumers track how their investments were performing. This technology, which has come to be known as “robo-advising,” has exploded in popularity and now provides a cheap, accessible alternative to human financial advisors.
The appeal of robo-advisors is that they charge much lower fees than traditional advisors and accept lower minimum account values. This means that consumers who are only able to spend small amounts can invest for the future. A 2014 PriceMetrix report found that the average financial advisor charges an annual 1.02 percent fee of the entire portfolio’s value. This is substantially higher than the fees that the automated robo-advisors charge, which range from 0 to 0.89 percent, with a median at 0.25 percent, according to a January 2017 Business Insider article. While a 0.75 percent difference in fees may not sound like much, due to compounding interest, it quickly adds up. For example, a $100,000 investment, assuming an average 6 percent market return over the next 20 years, would be worth a little over $255,000 when invested with a financial advisor. If that portfolio was invested with a robo-advisor, the value will be over $305,000, meaning that the investment with the robo-advisor has saved the investor over $50,000 in fees . Just as important, most financial advisors will not even take on any clients who have less than $200,000-$500,000, barring many low-middle income investors from utilizing their services. Robo-advisors will work with comparatively very low minimum balances – as low as $5,000 – making them much more accessible to the everyday consumer.
A financial advisor might respond to this by saying that while they may charge higher fees, their higher returns will justify those fees, and for certain years they may be correct. The technology for robo-advising is relatively new, but it is improving in quality and has shown strong returns in the past. According to a Condor Capital Management report on robo-advisors in September 2017, annual performance over the past two years averaged 13.4 percent across robo-advisor managed IRAs and taxable portfolios. As of yet there is simply not enough data on returns from robo-advisors to accurately compare them to returns from traditional advisors. As the technology improves, proponents of robo-advising argue that in theory, their returns will eventually exceed that of traditional advisors due to the lack of cognitive biases and conflicts of interest seen among traditional advisors, which according to the Department of Labor causes $17 billion in lost gains to investors each year.
While there are clear benefits of using a robo-advisor, they are not the best option for everybody. While a robo-advisor can provide a relatively easy, cheap and accessible investment option for consumers, it is important to remember that established financial advisors can provide additional portfolio flexibility, as well as a person to talk to and consult with regarding your finances. While everyone’s personal needs are different, a consumer who wants to take a more active role in their investing can consult with a financial advisor about their particular concerns and investment strategies, while the type of consumer who simply wishes to invest a modest amount of money and leave it be may wish to consider whether a robo-advisor is right for them.