August 4

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Robo-Advisor Vs Financial Advisor: Which is Best?

Ilir Salihi

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The robo-advisor revolution is having a massive effect on how people handle their money – especially for Millennials and “the digital native” generation who grew up with smartphones in their hands.

Artificial intelligence and robo-advisor technology have helped democratize investment advice and management. It's allowed people even with little or no savings at this point in their lives to benefit from advances in asset allocation and modern portfolio theory – at a fraction of the cost of a traditional advisor.

At the same time, financial advisors themselves are benefitting from similar technologies. They can offload tedious calculations, such as looking for tax loss harvesting opportunities, to computers. This lets good financial advisors focus more on the human side of providing financial advice.

What is a Robo-Advisor?

A robo-advisor is a computer platform that lets users input their current portfolio information, age, timeline, risk tolerance, and other personal information, and provides them with automated, algorithm-generated investment recommendations. Typically, a user logs onto a website and answers a detailed questionnaire.

The robo-advisor will then produce a recommended asset allocation. That is, it will provide a recommended allocation of stocks, bonds, international holdings, cash, and perhaps other asset classes. It will also recommend a combination of index funds or exchange-traded funds customized for the user.

Users can then buy a set of investments that match the recommended allocation, generally for a much lower cost than a traditional financial advisor would charge. Over time, the robo-advisor can automatically rebalance and adjust the portfolio to stay within the user's desired risk parameters.

History of Robo-Advisors

Most analysts consider 2008 to be the birth year of the modern consumer robo advisor. That year saw the launch of Betterment, which began taking in retail investor money in 2010, during the Great Recession. Financial institutions had been using similar technology to build portfolio recommendations for their clients since the early 2000s. But Betterment was the first firm to take the idea directly to the consumer market, bypassing traditional financial advisors, at scale.

Today, robo-advisors control more than $1 trillion in assets. The industry is growing fast, and some estimate that total robo-advisor AUM will grow by 17-24% per year and reach more than $2 trillion by the end of 2024.

The early robo-advisors strictly focused on building portfolios using asset allocation techniques pioneered by Harry Markowitz and Modern Portfolio Theory. That is, their focus was on investment management services.

However, improvements in algorithms and artificial intelligence have expanded robo-advisor capacity significantly. Today’s robo-advisor platforms are taking on more retirement planning tasks and other calculation-heavy functions. They are even moving into fields that were once the purview of traditional financial planners, such as special needs planning and Social Security planning.

In practice, most robo-advisor platforms today are actually hybrids. In addition to the automated investing component, most platforms also provide at least some limited access to a dedicated financial professional by phone, email, or Zoom conference. So robo-advisor clients still get the benefit of a human advisor, who can provide a human touch.

Baby Boomers and Generation X investors have been slow to embrace robo-advisory services. But Millennials have been flocking to these platforms. A recent Vanguard survey found that Millennials were more than twice as likely as Baby Boomers to be willing to use a robo-advisor to manage their investments.

Prominent robo-advisor platforms include:

  • Vanguard
  • Schwab
  • Personal Capital
  • WealthFront
  • Betterment
  • Facet Wealth
  • Stash
  • Ellevest

Related: What is a Certified Financial Planner (CFP)?

Advantages of Robo-Advisors

Robo-advisors have a huge cost advantage over traditional financial advisors. While traditional financial planning firms typically charge between 1 and 2% of assets under management (or the rough equivalent in fees), today’s robo-advisors usually have expense ratios around 0.2% to 0.5% of the investor’s total account balance.

Also, where traditional registered investment advisor firms (RIAs) and broker-dealers may have minimum investable asset requirements of $250,000 to $500,000 and up, robo-advisors make their services available to people with just a few hundred or a few thousand dollars to invest.

Starting from scratch? Betterment has no minimum whatsoever for its basic investment platform, and an annual fee of just 0.25%.

You don't get access to a financial planner at that level (for that, you still need to cover a $100,000 minimum investment and pay a higher annual fee of 0.4% of assets. So that would mean a minimum fee of $400 per year). But Betterment and most other robo-advisors still offer automatic portfolio rebalancing, dividend re-investment, and asset allocation strategies.

Robo-advisors are also available via the Web, 24/7, as long as you have Internet access.

They can also help take the emotion out of investing. Because it’s so easy to automate your rebalancing and forget about it, you don’t have to worry about responding to short-term fluctuations in the stock market – which is when many individual investors make big mistakes.

Robo-Advisors vs Traditional Financial Advisors: Which is better for you?

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Robo-Advisor Disadvantages

There are a few disadvantages to using Robo-advisors:

1. They use passive indexing strategies. They don't try to beat the market. Instead, robo-advisors put their clients’ money into very low-cost, passive vehicles that just try to replicate market returns, not beat them. You won’t beat the market. But historically, very few advisors or fund managers can beat the market, anyway, once you take expense ratios and trading costs into account.

Nevertheless, if you are a big believer in your ability to choose stocks that are likely to beat the market over time, a Robo-Advisor would not help you do that.

2. They can’t understand your family or psychology. Good advisors add value by talking their clients off of a ledge when markets have them at their most fearful. A robo-advisor can't understand you and your family as well as an in-person financial advisor can.

3. They are not yet very good at balancing complex financial planning considerations like tax planning, estate planning, small business planning, life insurance, and education planning/financial aid considerations.

Advantages of Traditional Financial Advisors

While traditional, human financial advisors cannot work as cheaply as a robot, they do have several advantages over their digital counterparts:

  • They can balance complex financial planning situations with competing priorities.
  • They can understand your small business needs and considerations.
  • They can better understand and anticipate your cash flow needs.
  • They can make insurance recommendations.
  • They can offer a broader array of potential investments, including individual stocks, bonds, closed-end funds, master limited partnerships, and other options.

Traditional financial advisors can also help you if most or all of your wealth is in a workplace retirement plan.

Related: How to Choose a Traditional Financial Advisor - Complete Guide

So which is better? That’s a personal decision. You might consider a robo-advisor firm if:

  • You want the benefit of financial advice and guidance, but you are young or just can’t cover the minimums for a traditional advisory firm.
  • You don't have complex financial planning needs. (E.g., you don't have to balance your investment needs against other estate planning, special needs planning, small business planning, or other considerations.)
  • You are comfortable doing investment transactions online.
  • You don’t want or need a lot of “handholding.”
  • You prefer a "do-it-yourself" approach.
  • You are sensitive to expenses and fees – which add up significantly over the long term.
  • You prefer the advantages of indexing and passive investment strategies to “active’ investing, which attempts to beat the market with stock selection and market timing.

A traditional investment advisor might be a better choice for you if:

  • You have enough investable assets to cover the investment minimum.
  • You have more complex financial planning needs.
  • You are nearing retirement and need to make some lifestyle-related decisions that aren’t accounted for in the computer algorithms;
  • You want the ‘human touch’ (and are willing to pay a bit more in fees to get it)
  • You believe a human advisor can add enough value to justify the additional fees.
  • Most of your wealth is in a workplace retirement plan, and you can't transfer it to a robo-advisory firm.

Robo-advisors are getting more and more sophisticated with every passing year. In a few years, robo-advisors may take on a more and more diverse set of services. They may even supplant weaker financial advisors. However, the very best financial advisors will welcome the change, because they can add value for clients in other ways. Offloading tedious calculations and rebalancing decisions to computers will allow the best planners and advisors to focus their efforts more on strategic wealth considerations.

Meanwhile, poorer and middle-class Americans who have been historically underserved by traditional financial services firms will have more access to professional financial advice – and hopefully, be empowered to make better decisions as a result.

About the Author

Ilir writes about personal finance, entrepreneurship, and digital marketing. When he's not creating content online, he's spending time with his family in Washington, DC.

Ilir Salihi


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