Disadvantages of Robo-Advisors: They Don’t Hold Your Hand
Robo-advisors were first introduced in 2010. It is predicted that robo-advisors will manage in excess of $US16 trillion by 2025. With such a large proportion of investments being directed mechanically, it is crucial to understand how robo-advisors work and what the disadvantages of robo-advisors may be.
What is a Robo-Advisor?
A robo-advisor is an automated financial advisor and investment platform. It uses a software algorithm to construct and manage your investment portfolio without providing you any human interaction.
Robo-advisors take emotion and human behaviour out of the investment process. They typically offer lower fees than would be charged by a human advisor, although some robo-advisor services do provide access to live advisors for an additional fee.
How Do Robo-Advisors Work?
The robo-advisor uses a computerized on-line app in which you answer a limited quantifiable questionnaire.
According to your numerical answers, the robo-advisor app then allocates an investment strategy to your numerical profile. The robo-advisor will build your portfolio typically using passive index ETFs.
Disadvantages of Robo-Advisors
- Robo-advisors provide no actual investment planning. A live advisor would take into account your financial circumstances, taxes, estate planning, succession planning etc.
- The fee advantage may not be that significant. Robo-advisor fees typically range from 0.25% to almost 1.0% (dependent on your account size). This is in addition to the fees charged by the funds they invest, in as would be the case with a live advisor.
- You will have limited investment choices. With a robo-advisor you may not have any discretion over the funds used as the selection is specific to the robo-advisor provider and is automated. The majority of robo-advisors invest in passive index ETFs, so there is no individual security selection available.
- Most robo-advisors do not provide human support for investment related questions. Support is only for technical and administrative issues to keep your account functional.
- Robo-advisors lack the capacity to consider all your financial circumstances when implementing investments. Some do allow you to upload all of your external accounts’ information (bank accounts, mortgages, loans, physical asset values, etc.,) but most investors are hesitant to do this for reasons of privacy and security.
- Robo-advisors are only able to provide investment strategies according to your quantifiable input. This may include age, income, debt, savings, time horizon and a self-assessed risk-scale number. Robo-advisors are not able to consider qualitative criteria such as significant life events, reasons for investing or your reactions to significant investment market shifts, nor are they able to challenge your self-assessed risk appetite – one of the most significant factors in investing.
- While robo-advisors take the emotion out of investing they cannot manage your emotions. They do not provide human counselling during market downturns. Without counselling to assuage your fears you may liquidate your account rather than stick to your long-term goals through volatile markets.
Key Takeaway: Robo-Advisors Won’t Hold Your Hands
With a robo-advisor, when you reach out for help or counselling there is no hand there to hold yours.
If you want counselling or an investment plan specific to your personal financial circumstances or have multiple investment objectives and/or specific securities considerations, then a robo-advisor is probably not your best option.
Depending on your investment strategy, risk tolerance, retirement plans, need for succession planning, etc., you may be best to work with a trusted investment professional who is knowledgeable about your total financial circumstances and qualitative concerns and can provide you with ongoing investment counselling.
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This content is provided for general informational purposes only and does not constitute financial, investment, tax, legal or accounting advice nor does it constitute an offer or solicitation to buy or sell any securities referred to. Individual circumstances and current events are critical to sound investment planning; anyone wishing to act on this content should consult with his or her financial partner or advisor.