When it comes to investing, everybody needs an advisor. But who is the best financial advisor and where to find them? What about Robo advisors? What are they and what can they do for me?
What is a Robo advisor
Robo advisors are a new invention on the financial market and the development which comes through the power of computer and internet. They grow very fast, for example the Assets under management (AUM) increase form 11.5 billion USD in April 2014 to 19 billion USD to end of December 2014. Nevertheless, this is only a very small fraction of the retail investment asset in the United States of 25 Trillion USD.
There are different occurrences in the market of Robo advisor, but in general they have the following characteristics:
They construct a portfolio for each investor, which contains usually exchange traded funds. Some have a large list of available ETFs, other have less ETFs in their program. The ETFs cover usually different asset classes, as US and foreign stocks, emerging markets, bonds. How many asset classes they cover and how big the available set of ETFs is, differs from provider to provider.
Some Robo advisors have a tax harvesting strategy already included, other charge an extra price for this feature and other don’t have it.
One of the main tricks in modern portfolio theory is the rebalancing of the portfolio. This means, that after some time the distribution of different assets in the portfolio changes on the basis of profits and losses in the portfolio. In order to keep this distribution constant, you have to rebalance the portfolio on a regular basis. This means, that you have to diminish one or more asset classes and increase other (or more) asset classes. Some Robo advisor do this, some don’t and still others charge for this service.
What does a Robo advisor cost
The main problem of all advisors are the cost, especially in investing. I have shown in several blog posts, for example in the article “Mutual fund versus ETF“, that cost will diminish your return on investment significantly. Therefore it is very important to keep the cost of the Robo advisors low.
When it comes to investment programs, you usually have to pay a management fee, which differs from program to program but in trading it is usually 2%. Robo advisors are a pleasant exception. They normally charge less than 0.5%, some do not charge any management fee!
Another fee is the account fee. This is also very enjoyable, because some charge nothing, others only for transfers, but you have to look at each provider.
The third cost is the investment expense ratio. This differs not only from provider to provider, it also differs from the kind of portfolio you choose. In general the Robo advisors try to minimize the cost and therefore they have lower investment expense ratios.
I put together a comparison between four Robo advisors. As you can see, they are all very cheap, but deliver a lot of value to the average investor.
You can download the pdf file here.
Most people don´t have the time or the desire to check on a regular basis their portfolio. For this person is seems to be a very good choice. The Robo advisors cover the main topics of portfolio theory and offer their service at a reasonable price. Therefore, you have to do one time the work to choose the right Robo advisor for you and then let them do the work. With this approach you are ahead the crowd.
Nevertheless I want to mention one warning. The last recession, the financial crisis has shown, that despite a distribution over several asset classes, the investor suffered heavy losses, because the different asset classes react in the same direction. This means, that you also look for some inverse products, that will arise if the market goes down.
I hope, that I could present you some valuable information for your investment decision. Let me know your thoughts.