Robo advisors came onto the investment scene less than a decade ago, but you can already see the effects sweeping through the industry. For investors, robo advisors are changing your investment options, fees and how you interact with investment services. Here are five notable ways robo advisors are changing the industry.
1: You No Longer Need a Ph.D. to Manage Your Investments
There's nothing wrong with managing your own investments… if you know what you're doing. Unlike me, however, most people don't have two finance degrees. Instead, they are lucky if they got a basic financial education from their parents. Many investors don't know the difference between an ETF and an annuity. And with the complicated acronyms, investment vehicles, capital gains laws and more, there's no wonder that most people don't feel comfortable managing their own investment portfolios.
With robo advisors, you don't need an advanced degree to confidently manage your investments. You just need to know basic information about yourself, such as your target retirement date, life expectancy and the answers to some questions about your risk tolerance. From there, you just have to connect a checking account. Your robo advisor will take care of the rest.
2: Costs Are Falling to All-Time Lows
In the 1980s, a stock trade required a phone call to your stock broker and a steep fee, around $50 per trade, to buy and sell stocks. Exchange-traded funds launched in 1993 and opened up the opportunity to buy a security similar to a mutual fund but traded like a stock. Competition and technology brought down fees and increased speed in the markets. Low-cost trades for retail investors are now here to stay.
One brokerage firm, Robinhood, offers completely free stock trades. For your overall portfolio, however, you likely want a few low-fee ETFs rather than individual stocks. Robo advisors put together a portfolio of low-fee investments made up of S&P 500 funds and similar diverse funds. You used to have to pay a fancy investment advisor a big fee for help building a portfolio like this, but now leading robo advisors do it for around 0.25% of your portfolio value per year. That's cheap for such a customized, personal service.
3. Investors Don't Have to Worry About Rebalancing
If you had put 80% of your portfolio into stocks and 20% into bonds five years ago, odds are your portfolio percentages would be far different today. There is an argument against portfolio rebalancing: Why would you sell off your best performers to buy more of your worst? But if you do like the idea of rebalancing, robo advisors make it much easier than it was in the past.
It used to be that portfolio rebalancing was a manual process. You would have to pay commissions to both sell and buy to bring your portfolio back into target alignment. With robo advisors, the cost and manual process are no more. Your robo advisor will automatically rebalance your portfolio, and you won't pay any trade commissions for your rebalance.
4. Tax-loss Harvesting for the Masses
Tax-loss harvesting was, for many years, something available to only the wealthiest investors. Tax-loss harvesting requires selling losing investments and immediately rebuying similar investments. This allows you to capture a tax loss in your portfolio, which can offset gains in other investments. Because it used to be a manual process, only those with huge portfolios were able to afford the cost of an investment advisor to go through the painstaking process. But again, robo advisors turned this model upside down.
Now investors with far lower portfolio balances can capture tax losses. For example, you can open a Schwab Intelligent Portfolios account with $5,000 and pay no fees on your account outside of fees charged by each fund. And it includes automatic tax-loss harvesting. Betterment includes tax-loss harvesting for all accounts and estimates a benefit of 0.77% per year in your after-tax returns.
5. Democratized Access to Quality Investing
While it still seems that Wall Street is run by and for the ultra-rich, quality investment options are available to a wider potential customer base with lower costs than ever before. Low costs, low minimum balances, automatic investments and investment management mean that more people than ever before can jump on the investment bandwagon and grow their assets for a better future.
With a growing wealth disparity in the United States, better access to investment advising at a lower cost is good for everyone. It adds competition, lowers prices and increases the quality of investment management for everyone. That is a win for every investor, not just robo-advising customers.
Robo Advisors Keep Getting Better
The robo advising industry is particularly exciting because it is just getting started. Improvements in the investment industry show up in robo advising and brokerage accounts regularly thanks to improved transaction processing times, artificial intelligence and machine learning. One can even argue that robo advisors are better than human investment advisors thanks to automatic tax-loss harvesting and rebalancing, at least the best ones.
And there are even some traditional wealth managers, like Farther, which automate some aspects of investing while still providing customized advice. This often means lower management fees and better-personalized service.
Computer-assisted investing is the wave of the future. Jump on board to ensure you get the best benefits of automatic investment management in 2018 and far beyond.