No doubt about it: Investing is one of the best ways to build wealth and secure your financial future, especially when you’re saving for retirement.
But actually doing that investing can be time- and work-intensive. There are countless options for investing in stocks — not to mention other assets like bonds, mutual funds or exchange-traded funds (ETFs) — how on earth are you supposed to decide what’s best to buy?
Enter robo-advisors: computerized algorithms that can allocate and manage your stock market assets for you.
You won’t have to do the painstaking work needed to build a diversified portfolio, and you’ll avoid paying big bucks to a financial advisor.
How do robo-advisors work, and should you use one?
Robo-investing is done by handing over your hard-earned cash to robo-advisors. Instead of investing in securities a la carte yourself, you pass the job to a computer algorithm. That algorithm then allocates and rebalances your assets through an automated process.
Sound complicated? It’s not. Here’s how it works.
- You give the robo-advisor details on your investment goals and risk tolerance — that is, how much risk you’re comfortable with and how much risk you can actually afford.
- A computer algorithm, usually backed by professional human research, creates an investment portfolio based on your responses.
- Depending on the specific service, you may or may not have more control over the individual assets you invest in, perhaps by choosing a portfolio of socially responsible investments, for example. Some robo-advisors offer tax-loss harvesting services, which can help minimize your tax bill. Note that tax-loss harvesting is only relevant if you have a taxable brokerage account. It doesn’t come into play if you have a tax-advantaged account like a 401(k), Roth IRA, traditional IRA or 529 plan.
Robo-advising usually comes at some expense, though some companies do have free options. While most robo-advisor services still cost money, the fees are low compared with what a human financial planner charges. Many services charge 0.25 to 0.5 percent of your account balance.
Along with saving you money by employing automatation rather than people, most robo-advisors double down by investing your funds in asset classes that carry low expense ratios, such as ETFs.
So what’s the catch? Well, when you hand over your assets for automated investing, you (obviously) lose some of the flexibility that comes with DIYing your portfolio. Of course, for people who don’t want to spend lots of time on stock market research, the lack of control isn’t so much a detriment. In fact, it’s kind of the point.
If you’re worried about trusting a robot with your investments, don’t be. In addition to charging low fees, robo-advisors tend to get better returns than human managers.
Not for you? Alternatives to robo-advising
Although there’s a lot to like about robo-investing, trusting your future nest egg to an algorithm can give some folks the willies. If that’s you, there are other investment strategies to consider.
Build your own portfolio
Building your own investment portfolio is always an option, especially given the information available on the internet nowadays.
Although taking matters into your own hands does give you about as much flexibility as you could possibly want, it’s much riskier. If you’re frequently trading stocks, you’re more likely to incur losses and possibly higher taxes.
Invest in a target-date fund
A target-date fund is a type of mutual fund that’s a common option in 401(k) plans. You specify when you plan to retire, and your money is invested and gradually reinvested as you get closer to your goal.
Choose a total market ETF
With a total market ETF, you’ll invest in a giant mix of companies that mirrors the makeup of the overall stock market. Because you’re investing across the stock market, you’ll avoid the risk of investing in individual stocks, but you’ll also be able to choose the ETF that works best for you.
Hire a human financial advisor
A human financial advisor or financial planner will cost you, but it may well be worth it. A professional can help you look at your personal finance picture and make sure you’re making wise decisions not only with your investments, but also when it comes to things like taxes, insurance and your estate plan.
Jamie Cattanach’s work has been featured at Fodor’s, Yahoo, SELF, The Huffington Post, The Motley Fool, Roads & Kingdoms and other outlets. Learn more at www.jamiecattanach.com. Senior editor Robin Hartill contributed to this report.