Robo-Advisors Part 1: What They Are + How to Determine if You Should Invest Your Money With One
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Welcome to the Stay Wealthy Podcast. I'm your host, Taylor Schulte, and today I'm wrapping up our technology theme for the month by talking about robo-advisors. However, there's a lot more that I wanted to share with you than I initially had thought, so I decided to break this topic up into two parts. This week, in part one, I'm sharing what is a robo-advisor, in plain English, of course, why I'd argue they've been around since the 1920s, and why I'd argue they've been around

and then who they are and aren't a good fit for. And then next week in part two, I'll be going through the pros and cons of robo-advisors, how to choose the right one if you think it's fitting for your needs, and some of the major pitfalls to watch out for. So I don't wanna waste any time today. Let's dive right in, in the rare chance that the term robo-advisor is new to you, or you're just still not exactly sure what a robo-advisor is. Let's get you quickly caught up here.

According to Wikipedia, robo-advisors provide digital financial advice based on mathematical rules or algorithms. The Balance, another website, says that robo-advisors are software products that can help you manage your investments without the need to consult a financial advisor.

And then finally, Fidelity says that robo-advisors are an affordable digital financial service that uses technology to help automate investing based on information investors provide about themselves and their financial situation.

My explanation is a little less technical. Put simply, I say that a robo-advisor is essentially a solution that sits in between managing your investments all on your own and hiring a full-service wealth management firm. And for that reason, you'll quickly find that in general, robo-advisors are more affordable than hiring a human financial advisor and more costly than simply doing everything on your own.

And like most things in life, you'll also quickly find that you get what you pay for. And that's not a knock on these services at all. I personally think that they're priced appropriately for the services that they offer.

An analogy might be something like LegalZoom. When it comes to drafting a legal document, you essentially have three options that aren't all that different than the investing world. You can either do the research and try to draft it on your own. You could hire a full-service law firm to take you through a customized formal process and draft the document for you.

Or you could find an in-between and you could pay LegalZoom for a broad-based template to help get you started. And depending on your legal needs and the complexity of your situation, that broad-based template that they provide to you and thousands of other people, it might just be sufficient on its own. Or you might need to spend a few hours of your own time reading some legal blogs and tweaking that template to your liking.

Or you might need to hire a human attorney to help customize that template and provide additional services on top to complement it. Drafting a legal document on your own would be the cheapest option, but it might take more time. A legal Zoom template will save you some time, but it's going to cost you a little bit of money. And of course, hiring a law firm to do all the heavy lifting for you is going to be the most expensive. But

It might either be necessary given your complexity, or you might just really value your time and prefer to spend it on other things rather than trying to learn how to draft legal documents or find some in-between solution and try to piece it all together. So how does a robo-advisor work? In short, a robo-advisor, or I should say the robo-advisor website, collects some basic information from you, such as your financial goals, your risk tolerance, your investing timeline,

And then it quickly runs your answers in real time through their proprietary algorithm to determine which of their model investment portfolio solutions they recommend for you. And once that's mutually agreed upon, you know, you have some say in that decision, of course. Once that's mutually agreed upon, the RoboAdvisor technology platform will help you get your money transferred over there. And then they'll take over the day-to-day investment responsibilities.

And if you're a new investor and you don't have any money to start with and you're starting from scratch, well, the RoboAdvisor platform will simply help you open up a brand new account and get it funded either with a one-time deposit or with recurring contributions. The main services that a RoboAdvisor provides are investment management and periodic portfolio rebalancing.

Some robo-advisor platforms, which we'll talk about next week in part two, also provide access to budgeting and financial planning tools, as well as access to a human for some general advice, which often is an additional cost.

Also really quick before we move on, some of the popular robo-advisors out there include FidelityGo, Vanguard Personal Advisor Services, Schwab's Intelligent Portfolios, and then Wealthfront and Betterment. And believe it or not, there are now close to 100 robo-advisors across 15 countries and we'll likely continue to see more and more come to market each year.

So on Charles Schwab's website, they suggest or they write that robo-advisors were born about 10 years ago. And while it's technically true that the term robo-advisor certainly became more well-known in the last 10 years, the term was actually coined in 2002 by Richard Corretto in a Financial Planning Magazine article.

That being said, I'd actually argue that the concept of a robo-advisor has been around a lot longer. I might even say since 1928 when the Vanguard Wellington Fund was born, which was considered the first balanced mutual fund in the United States.

The Vanguard Wellington Fund essentially introduced a new way for investors to get instant access to a diversified portfolio made up of stocks and bonds at a low cost and through just one single solution, just one mutual fund.

and sure it wasn't a computer or a fancy algorithm that was choosing and managing the investments but like a robo advisor the fund was and still is governed by a prospectus which creates rules and and guard rails around the underlying investment strategy and the target risk level so you know exactly what you're investing in and when you really drill down that's essentially what a robo advisor is offering right quick and easy access to a low cost

automated investing solution that takes a rules-based approach. So back to this Vanguard Wellington example, if back in 1928 you were done trying to handpick stocks and you're tired of paying a stockbroker, you know, 75 basis points or more to process every single trade,

you could now choose to invest in the Wellington Fund and let that fund manager do all the work for you. Now, the trading environment, as we all know, was much different back then, especially with trading fees and expense ratios. So to maybe improve this example and make it more relatable, let's just fast forward to current day. If today...

you were simply looking for quick and easy access to a low cost automated investment management solution that provides you with diversified global exposure across all these different major asset classes. Well, you could purchase the Vanguard Wellington Fund and you would pay the underlying expense ratio of 0.24% per year or 24 basis points per

Or maybe the Wellington Fund is too risky for you, or maybe 24 basis points is too expensive for you. Not a problem. You can opt for something like the Vanguard Life Strategy Conservative Growth Fund, which not only targets less risk, but is half the price of the Wellington Fund. And these are just two of hundreds of different investment solutions known as balanced funds, or what I often refer to as asset allocation mutual funds.

And they do and have done for decades what a robo-advisor does for you today, which is invest your money across major asset classes at a low cost and based on the risk level that you're targeting. And then second to that, their job is to keep the portfolio risk target in line by rebalancing that portfolio on a periodic basis.

The robo-advisors we know today just has a prettier interface and many of them have more venture capital funding and better, more creative marketing teams, which has helped them gain traction relatively quickly, especially with that millennial tech crowd.

But the primary services of a robo-advisor aren't all that different from a balanced mutual fund like the two Vanguard examples I just shared. And not too surprisingly, the most well-known robo-advisors are priced pretty similarly to these other balanced mutual funds. And I guess what I'm trying to say, in addition to saying that this type of solution has been around much longer than most people give it credit for, is

is that you don't have to necessarily transfer all of your money to a robo-advisor in order to get robo-advisor-like services if that's what you're looking for. Vanguard, Schwab, Fidelity, and just about every major mutual fund company offers low-cost asset allocation mutual funds, aka balance funds, that automatically manage your money based on your desired goal and risk level. Heck,

Most people listening right now are probably familiar with age based mutual funds. For example, the Fidelity Freedom 2030 fund. Well, that's an asset allocation fund that, like a robo advisor, is doing the investing, rebalancing and heavy lifting for you automatically based on your goal of retiring in the year 2030.

Really quick note that many asset allocation mutual funds or balance funds for that matter can still be very expensive, but there are plenty of low cost solutions out there way beyond just the two Vanguard examples. Those were just examples to share today, but there's plenty of low cost solutions out there for balance funds that compete very well with robo advisor pricing.

Now, before I get a bunch of hate mail from the robo advisor camp, I just want to stress that I'm not saying that the modern robo advisor as we know it today is the exact same thing as a balanced mutual fund. I'm just simply saying that their primary services, automated investing and rebalancing at a low cost are very similar.

But the robo-advisor landscape does continue to get more and more competitive, and they continue to add more and more services beyond portfolio management to help boost profit margins and, of course, fight off competition.

I'll be touching on the value of those additional services and again, pitfalls to watch out for and some of the pros and cons next week in part two. But first, let's talk about who is and isn't a good fit to work with a robo-advisor. And there are, of course, more nuanced reasons than we have time for today. But in general, here are a few situations where working with a robo-advisor might just be a good fit.

One, you're a new investor and you need a low cost solution without any big investment minimums to help get you started. Another one would be you're in the wealth accumulation phase of life where making money and saving money is way more important than trying to learn how to prudently invest on your own and try to pick the next hot stock.

Another one might be that your financial planning and tax planning needs are simple or even non-existent and you just need some help with the day-to-day investment management part.

And then lastly, maybe you or your spouse, maybe you already have technical financial planning knowledge. Maybe you've been listening to podcasts like this and you really enjoy it and you enjoy doing it on your own. So maybe you have the technical financial planning skills, but you just want to outsource the investment management part so that you don't get in your own way or fall into any behavioral traps.

So those are some solutions or some reasons, some situations why working with a robo-advisor might be a good fit. Again, there's a lot more of them, but in general, those are a handful that I came up with. And then here are some situations where working with a robo-advisor might not be a good fit or just might require some additional professional help from a human or maybe some additional services on top of what the robo-advisor is offering.

The first would be you've accumulated, you know, a healthy six or seven figures and you're just desiring a more customized portfolio solution that's unique to you and your needs. You know, think about that LegalZoom example of a legal document template that they use for every single customer that comes your way versus a personal customized legal document from an attorney.

Another one might be you're transitioning into retirement or maybe you're already retired and you're figuring out that the best, you're trying to figure out the best way to create income from your investments and learning that to do that and understand how to do that tax efficiently is more nuanced and more important than simply just saving and investing money and accumulating wealth. So you're going through a big life transition, you're going from that accumulation phase, that de-accumulation phase

And just a simple investment management solution just isn't cutting it anymore. Another one might be that your needs just simply extend beyond investment management, right? You have tax planning needs, insurance planning needs, social security timing, the list goes on.

And then lastly, it might be that you just simply place a lot of value on an intimate relationship with a human professional or maybe a team of professionals who are accessible and available to you as your life evolves and can help hold you accountable to tackling and addressing some of the important areas of your financial plan.

So in summary, the decision to use a robo-advisor versus doing everything yourself or hiring a full-service financial planning firm, it comes down to your unique needs and complexities, but also personal preferences and what's most important to you.

For example, like many of our listeners, and I've said this before, I'm certainly capable of doing my own taxes. But since I found my groove as a working professional, I've paid a CPA every single year, thousands of dollars to do the heavy lifting for me to help with strategic planning. And really important to me is to hold me accountable to taking action on important tasks that move the needle for me and my business financially.

Also, I could buy a cheap lawnmower and mow my own lawn, but my weekdays are busy with work and I don't want to miss time with my kids and my family, even if it is 20 minutes. So I find massive amounts of value in paying someone to do the heavy lifting in my yard for me.

And then, well, not a licensed marriage therapist. My wife and I could watch probably marriage therapy videos on YouTube, and I could argue that it's better than doing nothing at all. But my marriage is too important to be trying to manage it ourselves. So we've made a conscious decision to spend tens of thousands of dollars over the years to work one-to-one with a professional.

And, you know, perhaps as I rattle this off, perhaps you think I'm crazy for hiring someone to mow my lawn. And trust me, I've taken a lot of heat from from neighborhood dads over the years. You know, maybe you've been happily married for 40 plus years and you've never hired a marriage therapist. And that's OK. You know, we all have different needs and goals and situations and we all value services and things differently.

One of the common questions I receive from younger investors in their 20s and 30s is, how do I know if and when I need to hire a financial planner? And my short answer is always, you'll know. You'll know when the time is right. In other words, you'll start asking yourself more complex questions that you know are important, but that you don't have the answers to. And that's often a signal that you should probably get some version of professional help.

And I think that the same idea or same answer can be applied to this robo-advisor conversation. If you're currently working with a robo-advisor, I think you'll know, you'll feel it when and if you've outgrown their services and you need something more personal and customized to your unique situation, or you have a financial planning situation that requires just more nuanced discussion and technical planning.

If you're not working with a robo-advisor and you're considering it, I would say that you'll know pretty quickly after maybe even after reviewing their website, but if not, you'll know pretty quickly after, let's say, 30 to 60 days whether or not you're in the right place. And while I'd love to sit here and give you the textbook answer for who isn't and who is a good fit for working with a robo-advisor, I just don't think there is one. And I think there are dozens of things to be taken into consideration, some of which I just mentioned.

I'm also not here to convince you one way or the other. There is no one size fits all answer here. Hiring someone to help oversee your financial life, even if it is a computer, is a big decision and one that I think you need to work through on your own or in conjunction with your spouse.

The big thing that I want to leave you with today is that most of the major robo-advisor solutions are purely providing an investment management service and one that's priced similarly to other automated investment solutions, some of which have been around for decades.

And it's not entirely accurate to compare a robo-advisor to a full-service financial planning firm that limits the number of clients they work with, just like it wouldn't be accurate to compare TurboTax or even H&R Block to a specialized CPA firm, or to compare and contrast the pricing of LegalZoom versus the boutique attorney down the street from you.

If your biggest need is finding someone or something to just manage your investments for you at the lowest cost possible, then a robo-advisor might be something for you to consider. But like anything, it's not a solution that comes without some flaws, which I'll be getting into next week for part two of our robo-advisor conversation, where I'm going to be going through the pros and cons of robo-advisors, how to choose the right one if you find that it's fitting for your needs,

and some of the major pitfalls to watch out for that don't always make it into the media or some of the blog posts and reviews that you've read. Thank you, as always, for listening, and I will see you back here next week. This podcast is for informational and entertainment purposes only and should not be relied upon as a basis for investment decisions. This podcast is not engaged in rendering legal, financial, or other professional services.