Exactly what is robo-investing? The dozen or so firms offering this service use computer algorithms, rather than humans, to manage your investments. They do so at a considerable cost savings to you, the retail investor. They offer a substantial discount in the fees they charge, compared to more traditional financial service advisors.
Until recently, many investors had two choices when deciding how to manage your retirement savings such as an IRA or inheritance, for example. You could do-it-yourself (DIY). Pick some mutual funds, stocks or exchange traded funds your cousin or your fishing buddy suggests and invest for the “long-term.” That works fairly well as long as markets continue to gain year after year, but fails miserably when the markets turn, as they did during the financial crisis of 2008-2009.
Most individuals (and professional investors) held on throughout that decline only to sell at the bottom. Twenty-five years or more of savings were wiped out in 18 months. Many retail investors have stayed in cash ever since, missing a 100%-plus gain. Those who held on have made up most, if not all of, their losses, but it has taken over five years to do so.
The other option is to hire a financial advisor. Unfortunately, they normally have a minimum asset requirement of $250,000-$500,000 or larger. These advisors will charge you 1-2% annually and many also make additional fees through commission arrangements or “revenue sharing” deals with mutual fund managers.
The problem with the DIY approach is that most individuals are not able to invest their own savings, nor should they. They may excel at their chosen career but those skills do not normally transfer to money management. As for hiring an advisor, many investors can’t make the minimums; especially younger people, who are just starting to save.
Robo-advisors, on the other hand, normally set their minimums somewhere between $5,000 and $10,000. For that initial investment, they will manage your money via computer, charge you half of what a real-live advisor will charge (or less), and some even give you access to investment professionals, who will answer questions about the investments.
Some advisors such as Charles Schwab, the discount broker, charge no fees or commissions in essence, free money management, but readers should be aware that nothing is free. The robo-advisor may insist that 10% of your portfolio always remain in cash. That money can be used by the broker in any number of ways that can generate them a good return while making nothing for you.
Robo-advisers can also make money on the investments they select for you. They could, for example, invest you in higher-fee, exchange traded funds or their own brand of ETFs, if they choose. The point is that these robo-advisors are in this to make money, and they do. The fact that they do should not deter you from investigating this further.
Clearly, there is nothing new in how they invest you. There is no “HAL” out there whose artificial intelligence is going to make you brilliant investment choices and returns. All of these firms base their investment guidance using Modern Portfolio Theory (MPT), Efficient Market Hypothesis (EMH) and an analysis of your risk tolerance profile. These are all standard tools of any money manager. They simply down-load this into a computer and invest you accordingly.
If your investment skills are zero to none, robo-investing may be exactly what you need. Your returns may not be spectacular but at least you will have returns. For those of us who have sought the poor man’s answer to proper investing, this may well be it.