Managing Money Ready for the Investing Future? Say Hello to Robo-Advisors

by Ellen Sheng | November 06, 2020

If you're looking for a lower-cost way to manage your investments and achieve your investment goals, the solution might seem rather futuristic: enter robo-advisors.

Robo-advisors use algorithms to manage your investment portfolio. An algorithm is basically a mathematical model that utilizes multiple pieces of data to recommend or choose a particular solution or answer. Robo-advisory is becoming more popular, especially among younger investors. A 2019 survey by Investopedia found that 20% of affluent millennials (ages 23-38; median income of $132,000) currently use robo-advisors compared with just 13% of generation X (ages 40-55) respondents.

Even if you feel as though you have a solid understanding of investing, managing money takes time. You need to do your research, look at fees, consider interest rates and read up on trends. It’s not everyone’s cup of tea. I, for one, prefer coffee ... in that I'd rather leave the investing to someone else. Or so I thought.

My husband and I were in need of a big picture financial plan for our family, so we started working with a financial advisor. We’ve had scattered accounts for years — 401(k) accounts from various employers, IRA and Roth IRA accounts, a couple of 529 college savings accounts for our kids, checking and savings accounts — and wanted to consolidate everything.

But then our advisor took an extended sick leave, and we found ourselves researching other ways to manage our investments — in particular the robo-advisory trend I’d been reading about. Following are some questions that I raised — and the experts I tapped to help answer them — as I explored this brave new investing world.

Why use a robo-advisor?

Investing isn't just something you can do once and then forget about it. First, you need to identify your investing goals and assess your tolerance for risk to figure out the asset allocation (what percent of your investment you put into stocks versus bonds or other financial instruments).

Then, there’s maintenance required. Say you had half of your investments in stocks and the other half in bonds. Then the stock market sees huge gains, and you end up with 60% stocks and 40% bonds. If you want to stay on track with your plan, you need to adjust — a tactic called rebalancing.

A robo-advisor can help you make these adjustments. When you start with one of these digital platforms, you answer a series of questions about your age, financial situation, risk tolerance and goals. The algorithm at its core can then identify an appropriate portfolio choice — ranging from conservative to more aggressive — based on your answers.

One of the key ways robo-advisors support investors is by helping keep them on track toward particular financial goals over their full time horizon. Many people can choose their investments, but do not have the discipline to continue to monitor and adjust their portfolio, with the inevitable outcome that their goals are jeopardized.

“I think that's what's been really great for my clients is they've actually been starting to build wealth,” says Lou Abrams, founder of Fisecal, which provides financial coaching and education. “Before, this money was just sitting in a savings or checking account and they didn't actually know what to do with it,” he notes, but with a robo-advisor investing for them, “they actually started seeing their wealth increase.”

Another upside of using robo-advisors is cost. Robo-advisors generally cost about 0.5% of the assets being managed, whereas human advisors typically charge 1%. For a $10,000 investment, that comes out to $50 a year versus double that for a human advisor.

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I think that's what's been really great for my clients is they've actually been starting to build wealth.
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Who should consider using a robo-advisor?

Marshall Rocke, marketing manager at Citi Personal Wealth Management, notes that those investors whose needs are relatively simple and who aren’t investing significant amounts may want to consider exploring a robo-advisor.

That said, robo-advisors could also be suitable for those with more involved financial situations, too. Some people can rely on a robo-advisor for investments and human advisors for more complex questions. “They’re not mutually exclusive by any means,” Rocke says of a plan to consult a financial advisor and use a robo-advisor.

However, a certain amount of financial know-how is advised if you want to use a robo-advisor. Philip Olson, co-founder of The Art of Finance, says that on occasion he has seen investors with robo-advisor accounts put money into the wrong type of account.

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Some people can rely on a robo-advisor for investments and human advisors for more complex questions.
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For instance, one put retirement savings into a brokerage account, which is taxed, instead of an IRA, which has tax advantages for retirement savings.

As with any financial decision, just be sure to take a moment to review before moving any funds around.

What are the limitations of a robo-advisor?

Despite the name, robo-advisors cannot truly replace a human advisor. Most robo-advisors focus on investing, whereas human advisors may also deal with life insurance, setting goals for retirement and bigger picture estate and family planning.

Advisors may have been initially nervous about competition from robo-advisors, but that’s not the case anymore. Olson says he appreciates when clients also diversify with robo-advisors because, “it allows me to help folks with things that computers really can’t do very well. If you wanted to ask questions about using investments to start a business or buy a house, or you're saving the right amount for retirement, a robo-advisor won’t really be able to help you with that, but a human can … it’s the best of both worlds.”

Another thing to note is that robo-advisors typically offer a limited range of investments and only exchange-traded funds (ETFs) and not individual stocks. ETFs are passively managed funds that follow an index like the S&P 500. If you want to invest in mutual funds, individual stocks, bonds, currencies, options or in vehicles such as partnerships or closed-end funds, you would need to do so through other means.

In essence, what you get using a robo-advisor is a hybrid of a self-directed account and the service of a financial advisor. There’s no relationship that an advisor provides, but you do tap into and benefit from the expertise of professional money managers through the portfolio you invest in.

While there are limitations, robo-advisors have opened up investing to a new swath of investors, offering more people a way to plan for their financial future.

How can I get started with a robo-advisor?

As with any investment, determine how much you want to set aside to invest and have some goals in mind, too. Robo-advisors have different fees, minimum balance requirements and strengths so it’s helpful to do some research. Overall, an advantage of signing on with a robo-advisor is that the minimum investment to start can be more accessible than working with a traditional advisor.

Once you’ve determined the amount you're working with, you can open an account online by providing personal information and answering questions about your goals, age and so forth. It’s also helpful to know what type of account you want to open — whether it’s a Roth IRA, traditional IRA, taxable account or other type.

Most people have more than one goal — maybe it’s retirement and buying a house in five years. If that's the case, you can open more than one account so that the money is invested in a way that suits each goal. Whenever your circumstances or plans change, you can go back and adjust the answers so the algorithm will change your investments, if needed.

And, for added convenience, some robo-advisors also have mobile apps and provide banking services so you can check your investments, pay bills and track your spending all from your phone.

Woman sitting on a bench in a cafe checking her smartphone.

Robo-advisors have come a long way in just a few short years and are still evolving. And, since my investments don’t include a lot of real estate, private equity or anything complicated, robo-advisors seem ideal for my long-term investments.

However, I’ve found that I still need some in-person help for more complicated questions, so I'm glad to have the option to balance a human advisor with a futuristic robo-advisor.

Investing Technology Finance 101
Ellen Sheng

likes to learn about managing her finances by interviewing experts. Her stories have appeared in The Wall Street Journal, Forbes, Fast Company and Marie Claire.

The content reflects the view of the author of the article and does not necessarily reflect the views of Citi or its employees, and we do not guarantee the accuracy or completeness of the information presented in the article.

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