Robo-Advisors: How They Fare Against Target-Date Funds
David Dierking Aug 01, 2017
In case you are wondering whether mutual funds are right for you, you should read about why mutual funds, in general, should be a part of your portfolio.
How Do Robo Advisors Work?
In that sense, robo advisors may be helpful for younger retirement savers – those who don’t have much in the way of savings, don’t want to pay a lot for advice and just need to be pointed in the right direction. Investors getting closer to retirement and needing more complex solutions such as tax planning and guidance for how to begin withdrawing from IRAs and 401(k)s will likely find robo advisors to be less ideal.
Betterment and Wealthfront are two of the early robo advisors, but large asset managers such as Schwab, Fidelity and Vanguard have also gotten into the game. BlackRock and Invesco have both recently acquired smaller robo advisor companies to build their presence as well.
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Where Might Robo Advisors Be a Better Option?
Robo advisors have the ability to be more personalized. Target-date funds, as the name suggests, build a portfolio with a specific end date in mind, but they don’t take into account personal factors such as risk tolerance. For example, a young investor with 30 years until retirement and not comfortable with the stock market might be placed into a stock-heavy portfolio if choosing a target-date fund solely by the date. A robo advisor, in contrast, would take that risk aversion into account and suggest a more risk-appropriate solution.
Another reason is cost. Traditional financial advisors may charge 1-2% of the portfolio annually as a management fee. Even target-date funds carry an average expense ratio of around 0.7%. Betterment, for example, charges as little as 0.25% with no minimum balance required (although, you still have to pay the expense ratios on the underlying funds as well). If you choose ultra-low cost ETFs, you may be able to get a managed portfolio for less than 50 basis points. Plus, you may be able to upgrade to working with an actual advisor for an additional fee.
Check out our target-date funds section to familiarize yourself with this asset class and to learn more about different investing techniques.
The Limitations of Robo Advisors
Robo advisory has yet to become a significant presence in the retirement and college-planning spaces. These areas are still dominated by target-date funds, which are already considered cheap and successful options. Target-date funds are considered preferable thanks to their automatic enrollment features, ultra-low cost and easy systematic investing.
While a robo advisor can help remove the burden of overseeing a broadly diversified portfolio, it does require a degree of computer sophistication to keep track of things online and know how to make changes when needed. Consider also that robo advisory services only have a limited history with which to work, so the long-term track record of these services has yet to be established.
The Bottom Line
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