Why a Robo-Advisor Can Be Right For You
A robo-advisor? What the heck is a robo-advisor? We get that question a lot. Although robo-advisors have become very popular in recent years, many people don't really know how they work or why they would want to use one. Keep reading and we'll fill you in on the details and suggest several reasons why using one could be good for your wallet.
What is a Robo-Advisor?
To put it simply, a robo-advisor is an investment tool you use to automate your investment contributions and to pick investments which match your needs. They're also known as automated investing services or online advisors. These tools use computer algorithms and advanced software to build and manage your investment portfolio for you. Services range from automatic rebalancing of your investment portfolio to tax optimization and require little to no input on your part.
How Do They Work?
When you sign up with a robo-advisor service, the first thing you're going to be asked to do is fill out a questionnaire. This questionnaire is designed to assess your risk tolerance, your goals, and your investing preferences. After evaluating your answers, the robo-advisor will generally use their algorithm to recommend a portfolio of between five and ten portfolio choices, ranging from conservative to aggressive. If you don't agree with their recommendation, you're free to veto that recommendation if you’d prefer a different investment option. Their portfolio recommendations are largely built out of low-cost exchange-traded funds (ETFs) and index funds, which are baskets of investments that aim to mirror the behavior of an index, like the S&P 500. Once you set them up they kind of run themselves based on the instructions you gave them. That's the 'Robo' part.
Why Use a Robo-Advisor?
A lot of people get intimidated when they hear the word 'investments.' They assume they either need a masters degree in finance to understand them or to shell out a lot of money for a high-paying investment advisor to tell them what to do with them. This just isn't the case in today's investment world. The use of robo-advisor services makes it easier to get started planning for your financial goals by providing investment help at low cost and with low or no account minimums.
Here are Four Benefits to Using a Robo-Advisor
- Cost Effective: Since Robo-advisors are simply a series of computer algorithms which take the results of your questionnaire and give you recommendations on what to invest in, they're much cheaper than hiring a personal human financial advisor. Usually, it costs hundreds, if not thousands, of dollars in fees to pay a human to do what they do.
- Minimum investment requirements: Some investment service provider companies require $5,000 or more to open an investment account but many robo-advisor services have account minimums of $500 or less. Because of that and their low costs, robo-advisors let you get started investing quickly — in many cases, within a matter of minutes.
- Automatic Periodic Investing: You can set up automated investment amounts to be transferred from your checking or savings account directly into your investment each month. You just set a day of the month and an amount that's convenient for you. This way, you avoid forgetting to make the investment when life gets too busy. You'll be amazed at how fast your investment will grow!
- Limited Investment Knowledge Required: By filling out the questionnaire and letting the robo-advisor's algorithms do their thing, you avoid needing to become an expert at investing. As long as you know the basics of what the recommendation is attempting to accomplish (and that it matches your investment goals), you can have peace of mind that the system is going to do what it's designed to do.
What to Look for in a Robo-Advisor
When choosing the one that's right for you, there are generally four areas you need to look at.
- How much investment knowledge do you need to participate? For some of these, their algorithms handle the heavy lifting as far as how much you need to know about investing and participating is relatively straight forward and simple. For others, they offer services that require a more hands-on approach where you'll need to be a more sophisticated investor. Several offer hybrid services where you can get limited investment advice for a higher advisor fee.
- How much money do you need to invest to get started? Many robo-advisor services let you get started with zero money down while others require hundreds if not thousands of dollars to open an account with them. It seems to come down to whether or not they want to deal with small account balances and if it's worth their time to deal with the additional cost to service those accounts. Requiring a substantial amount of money up front to open an account may be their way of determining if the client is a serious investor or not.
- What's the minimum amount you can invest on a regular basis? Once again, it depends on their business model. For some of the well-known and established investment firms, they're going to require $50, or $100, or even $200 for each of your periodic investments. For others, you can invest as little as $1, $5, or $10. What you're considering here is what portion of your monthly budget you can afford to dedicate towards your financial future.
- How much is it going to cost me to invest? Here's another area where you'll see a wide variety of answers. For some robo-advisor services, you'll pay a flat fee per month or per transaction while for others you'll pay a percentage based on the total amount you have invested with them.
What I Use
I got involved with Acorns.com about six months ago through an ad I saw on YouTube. It came highly recommended on several of the business and leadership channels I subscribe to. After researching their company, finding out how their service works, and reading multiple reviews from third-party sites, I opened an account with them and began investing. The experience has been pretty good overall.
Their investing model is actually pretty cool. What you do is link your debit cards to their service and whenever you buy something, they round the purchase up to the next whole dollar amount and invest the change into your investment account every time it reaches or exceeds $5. While you may think that this is chump change, I was amazed at how quickly my balance grew without any extra effort on my part.
Another great way they offer for your investments to grow is that you can set up a weekly amount to be added to your investment account from your checking account. I have it set up for $5 per week but you can make it $10, $20, or whatever amount you're comfortable with. At $5 per week, I hardly notice the transfers and it's really a painless and easy way to make my savings grow.
As far as fees go, they take out a 'whopping' $1 each month to cover their commission. (At $12 per year, it's really a reasonable amount to pay for what you get.) When you sign up, you fill out a simple questionnaire which lets them know which of their risk-based investment portfolios are a match for your needs. (If you disagree, you can pick a different one if you want.) They even have charts which show how much your investment has grown over time along with ones that project how much you'll have invested over a period of years. Also, I like that their platform is visually appealing and simple to understand. There's nothing confusing about them.
At this point, I need to be compliant and let you know that F.I. Coaching LLC does receive an affiliate commission for recommending them to you. (A whole $5 if you sign up through our link. Whoo hoo!) On the other hand, even though I'm recommending this service and getting an affiliate commission, it's a service I actually use.
Investing doesn't have to be hard, nor does it require a college degree or a ton of money to get started. All it takes is the willingness to educate yourself on the basics and develop a solid game plan for reaching your goals. While robo-advisors are relatively new, they can provide a valuable, low-cost way for the Average Joe to begin investing and making their hard-earned money grow. So, look into them, do your research, and decide if using a robo-advisor matches your financial goals.