About a decade ago, a weird beast was created on the stock market. A new type of investment product called the Exchange Traded Fund, mostly known by its abbreviation; ETF. Many financial institutions started by laughing and denigrating ETFs to dissuade investors from leaving their expensive mutual funds. However, ETFs’ popularity has never ceased increasing since then. These days, I have a feeling of déjà vu with another weird beast that was created a few years ago. This new investment service is called a Robo Advisor. What is a Robo Advisor? We will answer this question and a lot more today.
What is a Robo Advisor?
Where is the “T” in Robo Advisor? This is mainly because we are not really talking about a robot making trades for you. The difference between a robot advisor and a robo advisor is the human factor behind it. In fact, a team of investment professionals are behind the robo advisor strategy. They are the ones who built the asset allocation, select the investment products and rebalance strategies over time.
If you invest your money with a robo advisor, you will be able to speak to a human (as it would be impossible to speak with the robot, right?).
The main advantage of investing in a mutual fund is to be able to get access to professionals who manage your money. Unless you have over $50 million to invest, you will not be able to talk to one of those guys. Mutual funds offer the opportunity to pool your money with the other small investors and invest with the big guys. The problem with mutual funds is that they are incredibly expensive!
On the other hand, robo advisors investment strategies are designed by the same kind of professional. Therefore, it’s not like you are investing your money with some geek who just computerized another cool algorithm. This geek is being supervised by investment professionals.
As is the case with a real advisor, the robo advisor provider will ask you to complete an investment profile questionnaire. The goal is to set your asset allocation according to your needs. Most robo advisor will have about 6 to 8 different portfolios meeting all kinds of investment horizons and risk tolerances. The whole process is regulated by a heavy compliance department, you don’t have to worry about how your money is invested. It will follow the same rules as if you were investing with a personal advisor.
Robo Advisor Vs Mutual Funds Vs ETF Investing
I guess the biggest difference between mutual funds and robo advisors (beside the fact they cost 50% less or more!) is the type of investment products they invest in. Mutual funds will usually aim for a stock picking approach. Therefore, you count on a team of humans to select the best companies in order to achieve your financial goals.
Robo advisors will invest your money in ETFs for the most part. Therefore, investing with a robo advisor is a little bit like ETF investing.The difference is that you don’t have to do the research about finding the best ETF or care about how to allocate your money among different assets. You have a question? You can always pick-up the phone and call the firm you invested your money with. As I already mentioned, robo advisors haven’t been created by some geek in their basement, most of them are operated by big financial firms.
The main difference with pure ETF investing is that you will most likely pay a higher fee with a robo advisor (as the asset allocation and rebalancing trades are included) than if you do it yourself. You will also have less flexibility with a robo advisor. It is not like you can build your own ETF portfolio and ask the robo advisor to manage it for you. You will be “stuck” with the robo advisor’s available options. Not to mention that you might also be forced to use the financial firm’s products. For example, if you chose Vanguard to become your robo advisor, you will not be able to invest in Spider or BlackRock iShares ETF products. This totally makes sense as the firm is not making much money out of the small MER fees they charge over the ETF fees.
Do you need and Advisor on top of your Robo Advisor?
Aaahhh, the financial planner in me cries each time I read an article about robo advisors and how they provide you with 95% of the information you need to manage your money. I guess part of the responsibility comes from the number of poor financial advisors focusing on selling investing products instead of providing financial planning information. The truth about financial advice is more complicated. In fact, a “real” financial advisor will most likely be a financial planner at the same time. The financial planner job is to meet with you and deliver a custom made plan for you to achieve your goals. He will cover the seven fields of financial planning which are:
- Personal finance: he will look at the way you setup your budget, your bank accounts, mortgage and other debts, etc.
- Insurance: he will calculate how much you need in insurance to cover you needs.
- Estate planning: he will give you advice about your last will and testament.
- Tax planning: he gives you insight about how to optimize your finances and save the most in taxes.
- Investment: he will help you make the right asset allocation and invest your money according to your goals.
- Retirement planning: he will deliver a plan including how much money you need to retire and how much to save in order to reach your goals. He will also run multiple scenarios with different investment returns. His software is also powerful enough to include various events in your plan such as the sale of a property, adding rental income, adding various sources of revenues, etc.
- Legal aspects: he will look at your legal situation such as your marital status and what will happen in the event of a separation.
This is just a brief overview of what a financial planner can do for his client. Obviously, you will tell me I’m talking more about a fee based financial planner in this case. Your halfway right. In fact, you can find these financial planners in banks or other financial firms if you are wealthy enough. Most firms will require that you invest a minimum of $250K to $500K to have access to such a professional. This is unfortunately, but that’s the way it goes!
Therefore, do you need a personal advisor on top of your robo advisor, I’d say that if you could find a “real” advisor, he will help you more than simply telling you how to invest your money. The tricky part is that if you don’t pay for a fee base financial planner, the only way your advisor can make a living is by selling you… investments!
This is why I understand that for most people, switching their money to a robo advisor will not change much in their lives!
Robo Dividend Advisor?
I must admit that I’ve haven’t spent many hours looking for a robo dividend advisor, and I haven’t found one. This is one of the flaws shown by robo advisors; they are built for mainstream investors. As they invest in ETFs for the most part, robo advisors concentrate on the asset allocation. They don’t focus on dividend paying stocks or other types of strategies. Their goal is to provide an efficient way to manage basic asset allocation.
Why I do not use one
Well… I just told you; robo advisors don’t manage a dividend growth portfolio. Therefore, it doesn’t make sense for me to use one. I also dislike the lack of flexibility linked to any “managed-for-you” product. But that is because I want to manage my money! Hahaha!
Who should use a Robo Advisor
Any investor with money in a mutual funds should at least do this first step: getting about the same kind of asset allocation, but paying 50% or less in fees with a robo advisor. Unless your financial advisor provides you with a complete retirement plan and the additional advice I mentioned earlier, there is no point of paying him simply to fill out the paperwork to invest in a mutual fund. This era has come to an end, and you should not be one of the last sponsors of this old business model.
If you are not ready to manage your portfolio as a whole yet, but you are thinking about making the switch. You can also use a robo advisor for a core portfolio that is being managed within specific rules and will help reduce volatility in your portfolio.