Automated robo adviser software applications use algorithms to buy and sell securities according to predetermined user preferences. You tell the robo adviser your age, when you will need the money and your risk tolerance. You then sit back and let it automate.
Robo products, developed after the 2008 financial crisis, have gained traction, especially among young and novice investors. The tools are simple and steer clear of complex investing strategies. Most people, after all, do not have unique investing needs and can benefit from off-the-shelf solutions designed for standard profiles.
Moreover, everyone, even the savviest financial geeks, can fall prey to behavioral biases and emotional traps. Robo investing is a lesson for avoiding those traps.
Getting your toes wet
Robo advisers appeal to beginner investors, who usually have more limited financial resources as well as less knowledge and experience. But novices do need to start investing somewhere, both to gain confidence and build assets. Should they kick off their investing with a robo program or turn to a human financial adviser? There are arguments for both. Robo advisers offer:
Robo advisers do not provide extra bells and whistles, such as:
Emotions cloud everyone's judgment
Less is more. It is a primary advantage of robo advisers that they are entirely hands off. If you are letting a program transact for you according to mechanical rules, you will be less tempted to overreact to market volatility or make rash decisions. Passive investing strategies have proved increasingly successful as well as cheaper to implement.
Some investors still like researching and investing on their own, in a (usually futile) attempt to beat the market. If so, they can always set aside a modest portion of their assets, like 5%, to use as "mad money" for taking a flyer. Alternatively, they can cheaply buy index or exchange-traded funds in a self-directed brokerage account. For example, a catch-all ETF like SPY encompasses the S&P with one click. They can also use target date funds for retirement accounts.
But best of all, with emotions stripped away, an algorithm is most likely to achieve the holy grail: buy low, sell high and rebalance systematically.
How well do robo advisers perform?
It is almost impossible to tell. Robo advisers have only been around for about a decade. That is short for proving track records, and longitudinal data remains insufficient for ranking robo advisers against old-fashioned money managers. Most robo advisers do not disclose performance statistics, and, anyhow, it may take years to confirm gains from even simple programs like tax losses, let alone more complex strategies.
The problem is partly one of apples and oranges, and side-by-side comparisons only work for specific funds or portfolios. Since various robo platforms' metrics vary significantly, even a basic distinction like the amount kept in cash versus securities changes the equation.
If you are considering a robo account, you should start by discussing with a traditional adviser whether it would meet your current needs.
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