The FinTech Chemist: Is Going Robo Right for You?

Studying the properties and composition that make up the FinTech ecosystem

Welcome to this week’s industry analysis with the FinTech Chemist. While I may not be literally mixing solutions and preparing reagents, I am studying and testing out the latest and greatest in FinTech. In the past decade, we’ve seen a rise in robo-advisors. While their low-fee, hassle-free approach to investing is enticing, the question here is: are they worth it?

According to Newton’s Third Law of Motion, “For every action, there is an equal and opposite reaction.” When the financial crisis struck in 2008, many people lost trust in the financial services industry. In response, robo-advisors were made available to the public, and experts are saying it’s set to be over a USD 1-trillion-dollar opportunity by 2020. The top five robo-advisors in the US – Betterment, Wealthfront, Personal Capital, Schwab Intelligent Portfolios, and Vanguard Personal Advisor Services – continue to increase their assets under management. Robo-advisors have democratized investing in a field where investing was reserved for the upper echelons of society for a long time. Now, instead of sitting down with a certified financial planner, there are options for everyone. However, like any experiment, you have to weigh the pros and cons.

Top three pros of using a robo-advisor

  1. You receive professional investment management at a fraction of the cost: For instance, Wealthfront will manage accounts as small as $500. Meanwhile, Betterment has no minimum initial deposit requirement. You can open up an account with no money (however, Betterment does require that you set up an automatic funding provision to do this). On the expense front, both robo-advisors charge an annual management fee equal to 0.25% of your account balance. That’s just a fraction of what traditional investment managers charge. Charles Schwab Intelligent Portfolios has no annual management fee at all. The general fee range for robo-advisors is between zero and 0.50%, though some robo-advisors charge higher fees for expanded services.
  2. Tax-loss harvesting: According to Investopedia, “Robo tax-loss harvesting is the automated selling of securities in a portfolio to deliberately incur losses to offset any capital gains or taxable income.” So, what does this mean for the investor? Since robo-advisors are run by sophisticated algorithms, the platforms can identify assets with unrealized losses and sell them. Strategically selling assets at a loss can help to offset realized gains, which minimizes the amount of taxes investors need to pay on these gains. Any chance to pay Uncle Sam less sounds like a win to me.
  3. 24/7 availability: As long as you have a connection to the internet, you can access your accounts. Robo-advice never sleeps! This is especially ideal for consumers who like to check their balances on the go, or work “non-banking” hours. Human financial planners cannot provide a 24/7 service.

Top three cons of using a robo-advisor

  1. You still prefer a “human touch” when it comes to investing: The reason robo-advisors are such an inexpensive option for investors is that there is zero interaction with a human advisor. There are limited options to discuss your portfolio, and to those that like to have actual conversations, or have more emotional reactions to market shifts, then a robo-advisor may not be the best choice.
  2. They have yet to experience a bear market: The vast majority of robo-advisors have not experienced a full market cycle. They were a response to a crisis, but investor fears have been mounting about how platforms will perform if there’s a downturn in the market. In a slumping market, will clients continue to invest in automated platforms that almost exclusively track passive investment products?
  3. You can’t personalize your investments: Robo-advisors typically offer low cost, diversified portfolios by offering to invest in exchange-traded funds (ETFs) and index funds. There are tons of asset classes, and if you’re an investor seeking an extremely diversified portfolio that includes more investment choices than the diversified US and international stocks and bond ETFs, then you might not be a right candidate for a robo-advisor.

Ultimately, the choice to use a robo-advisor is very personal. Consider the pros and cons of robo-advisors carefully before making any decisions. Now, onto my next scientific… I mean FinTech hypothesis adventure. And, as always, remember to take your vitamins!

Read the previous edition of The FinTech Chemist.