A recent Harvard Business School study showed that most people trust an algorithm more than they do the judgement of their fellow humans. So when it comes to investing, should you use an automated robo-advisor to maintain your portfolio, or are you better off spending a little more money on a flesh and blood financial advisor? Both will make adjustments to your investments based on your financial goals, but there are trade-offs that set them apart. Here’s a look at how they differ, and why you might opt for one over the other.
The difference between a robo-advisor and a financial advisor
Robo-advisors are the ultimate “set it and forget it” strategy for passive investors, as they’re run by investment management companies that use computer algorithms to manage and rebalance your portfolio. Aside from some initial questions that determine your risk tolerance and intended time horizon, portfolios run by robo-advisors require very little interaction on your part.
Financial advisors also maintain your portfolio, but they can holistically manage other aspects of your personal finances, too, including other investments, day-to-day budgeting, and estate planning. They can work for you on an ongoing basis or temporarily, and they’ll be available to discuss your finances in regularly scheduled face-to-face meetings.
Robo-advisors typically charge about 0.25% to 0.50% for the amount managed per year, and some won’t have any required account minimum to set up your account. Financial advisors, on the other hand, will cost you roughly 1-2% of your assets under management for ongoing portfolio management, although they can charge a flat fee of $2,000 to $3,000 for the one-time creation of a full financial plan, per Smart Asset.
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Reasons to choose a robo-advisor
A robo-advisor is a great option if you’re happy with an “all-in-one” investment strategy, are comfortable with modern portfolio theory, don’t have a lot of other assets to manage, and want to keep costs as low as possible. The savings are no joke, either. As explained in Barron’s:
Consider a 30-year-old with a $50,000 retirement account that earns an average of 7% through a financial advisor whose fees add up to 1.5% a year (that’s on the cheap side). Assuming no more investments in that account, at age 65 the investor would have $314,500. Using a robo with a total fee of 0.5%, given the same investment and same rate of return, the account would be worth $448,000. That mere 1% a year would reduce total returns by $133,500.
The other benefit is that robo-advisors don’t have the same account minimums financial advisors usually require (some minimums can be as high as a million dollars). This makes them a great choice for newer, younger investors. Plus, some robo-advisor services offer a hybrid program that allows you to consult with financial advisors as needed, although doing so will usually come with an additional cost.
Reasons to choose a traditional financial advisor
If you prefer more active management of your investments or have other assets aside from an investment portfolio, you might be better off with the holistic services of a financial advisor. Unlike a robo-advisor, which will have very limited insight into your complete financial picture, a financial advisor will be able to give you professional advice based on the totality of your finances: estate planning, tax strategies, retirement drawdown strategies, debt refinancing options, even making sure you have an adequate emergency fund. The tradeoff for these services is cost, but a good financial advisor could potentially save you enough in the long run to make it worth it, especially if you have no idea what you’re doing.