In the past, if you wanted someone else to manage your investments for you, a natural step was to go to a financial adviser.
A huge lack of investment education out there meant beginners had to make a choice between paying for advice or muddling through and not really knowing what they were doing.
But advisers can be expensive and often gear themselves towards high value clients because they’re going to pay more for their services.
This isn’t to discredit the adviser world - if you have complicated issues like inheritances and tax planning, or you’d rather have the peace of mind of a professional running your money, they can be a massive help.
But that still leaves a big gap in the market for those that can’t afford them.
Lots of automated investing tools have been developed in the past decade or so to try and cater to this group of people. Half-way houses like robo-advisers have probably proven the most popular.
What is a robo-adviser?
A robo-adviser is like an automated financial adviser.
You usually access one on an app or via a web application.
You punch in some personal information, like your age, income and any debt you have, and the robo-adviser will provide you with some investment options.
Your money will then be automatically invested into whatever assets the robo-adviser determines are right for you.
This differs from a lot of guidance platforms because the robo-adviser (like a human financial adviser) will take that final investment step for you rather than leaving you to make the investment decisions.
How do robo-advisers make money?
These services don’t come free.
In return for providing you with advice and facilitating your investments, a robo-adviser will charge a fee.
There is no fixed amount as different companies charge different fees.
But it’s common for a robo-adviser to levy a 0.25% charge on the value of your assets on an annual basis.
Real financial advisers tend to charge much more than that, with 0.75%-1% a year or more not being uncommon in the industry.
Aren't all robo-advisers the same?
On a superficial level, most robo-advisers provide a similar set of services. But then so do real financial advisers and investment platforms. The difference is in the details.
Robo-advisers vary in the fees they charge, the technology they use and the investments they offer. They also require varying minimum investment amounts to get started.
To make an analogy, the odds are you have a favourite price comparison site for booking flights. Maybe you prefer the tech it offers or it gets you better prices.
Robo-advisers are similar.
Even if they all share a similar goal of facilitating investments, they’ll offer different features which you may find more or less appealing, depending on your own preferences.
Do robo-advisers beat the market?
There is no cut and dry answer to this but, for the most part, it seems as though the answer is ‘no’.
Robo-advisers tend to match the risk levels you tell them you want by putting your money in a blend of bonds and index ETFs. Some even keep a portion of your funds in cash.
Bonds can be a sensible diversifying asset, mitigating the risk of shares, but with bonds offering low yields over the past decade, this part of the portfolio can end up holding back broader gains elsewhere in the portfolio.
That can mean your overall account lags equity indices like the S&P 500.
And because robo-advisers can charge a fee on top of the index tracking funds they put your money in, you’ll likely always slightly underperform the market here because of the fees.
To illustrate this point, it’s worth looking at some data.
One analysis of a set of 20 US robo-advisers from the end of 2017 to mid-2020 found that the highest annualised rate of return they provided was 4.71% (Source: BackEnd Benchmarking).
In contrast, the S&P 500’s annualised rate of return for the same period was 9.53%.
That means the best-performing robo-adviser had a return of less than half that provided by the index they could most easily be benchmarked against.
In practice, that means buying into an ETF tracking the S&P 500 in the same period would have yielded you a substantially higher return than the best-performing robo-adviser.
It’s also worth remembering that this was the best performer in that group of 20. Three of the robo-advisers analysed would have given you a return that was less than the rate of inflation.
Can you lose money with robo-advisers?
Investing can always mean you lose money and robo advisers are no different.
As long as your money is in the financial markets, there’s a chance it can fall in value. Robo-advisers won’t make you immune from that.
The other thing to be wary of is losing money via poor performance.
As we saw in the example above, some robo-advisers actually provided a return that was less than the rate of inflation.
If that does happen then you are effectively losing money in real terms, even if it looks as though you’ve gained a bit.
Are robo-advisers safe?
Robo-advisers often provide customers with a less risky set of investment options.
But that doesn’t mean they’re risk-free.
All investments carry some level of risk with them, so even for those robo-advisers that do offer less risky options, there’s still the chance things can go wrong.
You also have to remember that robo-advisers will base their offering to you on a mix of your preferences and finances.
That means you can end up investing in riskier assets with a robo-adviser too.
To mitigate this, the simplest option is to find out what your money is going into and make sure you’re happy with the levels of risk that come with it.
What's the difference between a robo-adviser and an online broker?
Robo-advisers and online brokers are both set up to facilitate investments.
The big difference is that brokers provide you with a platform from which you are free to choose what you want to buy and sell. That could be US and UK stocks or ETFs and investment trusts. They’re often called ‘execution only’ platforms because that’s what they offer - the ability to invest. They won’t do it for you.
Some of them may offer advisory services as a conduit to that but, for the majority of people, online brokers act as a means by which they can open a general investment account and pick their own investments.
In contrast, most people use robo-advisers because they want a company to make their investment decisions for them.
When robo-advisers might seem like a good idea
1. When you’re new to investing
New investors can often feel overwhelmed by the stock market.
Lots of technical terms, numbers and statistics can make it hard to figure out where to begin and what to buy.
As a result, many people find it easier to use a robo-adviser that will do that work for them.
But a lot of people find the step to doing it yourself makes just as much sense. If a service will charge you to put your money in a range of ETFs, it may be that you could be the same and miss out the middle step.
2. When you want to get a return, but not take on lots of risk
Looking at the returns we saw above, you might think that robo-advisers don’t provide the level of return on investment that you’d like to see.
But lots of people want to see their wealth grow with as little risk as possible.
Lots of robo-advisers have that goal in mind too and thus take a very risk-averse approach to investing.
That may not be your style but, completely understandably, it is for lots of people.
3. When you don't have lots of money to start with
Lots of new investors want to have some sort of advisory service to help get them started.
But financial advisers are often pricey and don’t want to deal with customers that only have a small amount of money.
Robo-advisers can be a good option for these new investors because they often have low minimum investment requirements and their fees are, compared to real
advisers, comparatively cheap.
Quite a lot of the time though, these new investors find that what they are looking for is more of a guiding hand than someone to do everything for them.
In this case, it can make sense to do a little bit of groundwork yourself into simple investment options that match your tolerance for risk and use useful guidance from trusted investment sources to make your own decisions.
4. When you don’t have time to research your investments
Researching prospective investments is time consuming.
You may end up looking at a company’s finances, products and services, executive team and competitors.
Doing this takes a while and you have to know a bit about investing in order to do it.
That’s why many people prefer using a robo-adviser. It does this work for you, at least in principle, which makes it a more appealing offer for anyone that doesn’t want to spend time stock picking.
Things to look out for when looking at robo-advisers
There are a few things to make sure you understand before you take the plunge with any investment product.
Robo-advisers are no different.
Fees and charges
Robo-adviser fees may be lower than those charged by human advisers but they’re still fees and you’ll still have to pay them.
Over time these eat into your return and because lots of robo-advisers invest in ETFs, it means you can also end up paying several sets of fees, as opposed to just one.
Some robo-advisers tier their fees as well, meaning smaller amounts of money incur higher charges, something that’s not always ideal for people investing small amounts of cash.
You can’t choose your own investments
Robo-advisers don’t give you a great deal of flexibility with your investments.
For people that have no interest in learning about investing but still want to put their money somewhere, that might not be a big problem.
But plenty of investors want to pick at least some of their investments.
Another component of this is that you have limited options when it comes to actually discussing your investments.
The whole point of robo-advisers is to cut costs by providing you with an automated service and not a human one.
The obvious upside of this is cheaper fees. But it also means you lack a human touch to your service. You can’t discuss prospective investments or ask about those that have already been made.
That’s not to say robo-advisers won’t offer any kind of customer services but they generally won’t provide you with the sort of details that a human adviser would.
And that’s often broader than simply telling you “buy X and sell Y”.
Robo-advisers often use a very simplistic formula of taking some personal information and saying ‘buy this’.
That means they can’t tell you much about, for instance, whether or not you should be investing in an ISA or how much you should be attempting to invest each month.
And it might not seem like a priority but if you’re an investor who likes a bit of human reassurance with your financial advice, you won’t get that either.
You might pay more for a qualified independent financial adviser but sometimes the softer side of being able to phone them for a chat or sit down and discuss your needs is worth it.
What will happen to robo-advisers in a major market crash
Robo-adviser portfolios aren’t more or less likely to be hit by a crash as they’re all different.
So the susceptibility of your investments to a market crash will depend on the robo-adviser you use and how they invest.
That being said, you need to keep an eye on what you’re actually holding in order to figure that out. The robo-adviser won’t do that bit of legwork for you.
Another problem can arise when the robo-adviser starts making decisions for you. For example, one robo-adviser locked client accounts when Brexit happened to stop them from making any moves amid the turmoil the vote caused in the markets.
For many investors that may have been the right move to make. But it may also be the case that you want to access your investments and start moving things around. That’s not ideal if a firm can cut or limit your access to them.
Are Robo-advisers worth it?
Robo-advisers were the toast of the financial technology world about a decade ago. They were supposed to usher in a wave of new investors and give people with smaller amounts of money access to low cost advice.
The reality has been slightly different. Lots of them remain unprofitable and many have shut down, including offerings from big investment houses like UBS and Investec.
But aside from their own operational problems, the main question many investors have with robo-advisers is, well, what’s the point?
So many of them simply direct users to funds or index trackers and then slap a small fee on top for doing so. The thing is, in many cases you could easily buy into those index tracking funds yourself and skip the robo-adviser fee.
That’s not to completely denigrate some of the services on offer. Some people do want low-risk investments, without the headache that comes with figuring out what to invest in. Lots of robo-advisers do that and, to give them credit, they generally do it at a much cheaper price than was on offer in the past.
But for anyone that’s willing to do a little bit of research and make their own investment decisions, it may be that the growth of simple, accessible guidance around investing has meant it’s easier than ever to take control of your own money.
(Source: BackEnd Benchmarking Robo Report — https://www.backendbenchmarking.com/the-robo-report)
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