Automated investment advisory services aim to be as easy to deal with as C-3PO, the Star Wars droid famous for his eagerness to help.
Unlike C-3PO, however, robo-advisors can't talk. That means you can't interview them to understand how they approach investing and if their approach is in sync with yours. But you can use some of the same tactics you would with a carbon-based (ie, human) financial advisor: Understand your goals, the scope and limitations of what the digital service offers and how to kick the tires.
"Robo-advisors are to investment advisors what TurboTax is to tax preparers," says Charles Sizemore, founder of Sizemore Capital Management LLC in Dallas."If you have a complex situation, TurboTax won't help you. If you have a complex situation, the more wealth you have, the more tailored an approach you need." Sizemore taps into some automated services for his own clients and advocates consumers take an a la carte approach, using digital advisors for basic investments, such as index funds, and human advisors for more complex decisions.
Most digital advisory services are geared toward millennials, those 20-somethings and 30-somethings for whom retirement planning is simply all about saving, says Adam Nash, CEO of Wealthfront Inc., a digital financial advisory firmbased in Palo Alto, California. "They've grown up with technology, and now they have jobs and have to save and invest," Nash says. Millennials are also accustomed to handling banking, travel arrangements and, of course, online shopping, so most understand the concept and logistics of self-serve financial advisories.
Those just starting out usuallyhave simple, straightforward needs and mainly want to ensure their portfolio growth isn't undermined by high fees. Typically, robo-advisors park money in low-fee funds such as index funds or exchange-traded funds, amplifying potential returns, executives at digital services say.
Preretirees and early retirees face a complex array of decisions, says Karin Risi, head of Vanguard Personal Advisor, based in Malvern, Pennsylvania. "Their needs are greater, and their portfolios are more sophisticated," she says.
One filter you can use: If you complete the long form for your annual income taxreturn, you may need a personal advisor. If you complete the short income tax form, an automated advisor may be sufficient for the time being.
Scope of services.The obvious difference between robo-advisors and humans is that you can't expect a robo-advisor to talk you through a tough stretch when your portfolio is getting hammered. Although robo-advisors can't prevent you from panicking and making a major misstep, such as dumping a mutual fund that's temporarily down, they can offer instant reports that address anxiety in a different way, Nash and executives at other digital advisories say.
For example, Nash says, a human advisor would likely look at your portfolio four times a year, at most, and recommend any rebalancing then. But a well-structured robo-advisor will automatically rebalance your account to reflect current economic and market conditions. That means you may be less worried about reacting to fluctuating markets because you know the robo-advisor is taking care of it, Nash says.
If you suspect you may need afinancial advisor within a few years, you may consider a robo-advisor that can transition you to an advisor within its network.Betterment, for example, is developing a network of financial advisors to work with clients as their needs grow, saysJon Stein, CEO and founder of the New York-based digital advisory.
Vanguard offers personal advisor services for a fee of 0.30 percent. The human advisor starts with the computer-generated plan and then customizes it according to the client's needs.A service that offers a continuum lets you escalate the level of service as you need it, Risi says, precisely when life is complicated by a welter of decisions about children in college, aging parents and career decisions.
If you are, or anticipate, quarterbacking the efforts of an estate lawyer, tax accountant and insurance agent, you may need a full-fledged financial advisor to tie it all together, Risi says. "Even if you have the inclination and aptitude to manage your own investments, you might not have the time," she says.
How to kick the tires.Robo-advisors are designed to detect your investing goals by asking key questions, but no digital advisor can be as thorough as a thoughtful, experienced human advisory, executives at digital advisories say.
You can glean insights into a service's approach by going through the goal-setting exercise most services use as an opener, Sizemore says. Any advisory that quickly spits back investment recommendations based primarily on age is probably not credible, he says. "If it starts with age and doesn't get more nuanced, that's a terrible way to do things, for lack of more creative options," he says. "Age, income and net worth are the quantitative factors that matter most."
About 25 percent of new customers call Betterment's customer service line in their first week of signing up, Stein says, usually to make sure they understand some of technicalities of setting up their account. Sizemore recommends calling just to see how well the service staff responds to your questions. "If you hate calling customer service centers in general, you want to make sure you are satisfied with the robo-advisor's support before you get very far into the relationship," he says.
Other red flags:
- A quiz or diagnostic that flat-out asks you what your risk tolerance is wont be an effective test.Most people think they have stronger stomachs than they do, Sizemore says. Look for questions that put risk tolerance in terms of your likely emotional reaction to various scenarios.
- Does the system clearly outline what you must do to transfer to a different advisor? It should be a simple, straightforward explanation that is easy to find on the site.
Part of the appeal of digital services is that they can link to your other financial accounts, but you can't see how well that works unless you set everything up in a full-fledged account. That full-fledged account is more difficult to dismantle, however, if you then want to try another service,executivesof digital advisory firmsconcede.
An alternative is to sign up for the lowest level of service with the minimum amount of money and see how it goes, Nash says. Moving a $10,000 trial account around is easier than transplanting your entire investing life just to experiment with various services, executives say. Then when you find the Goldilocks service, the one that's just right, you can settle in for the long haul.