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Robo-advisors and traditional financial advisors both help investors to construct portfolios for investing and growing their savings. The biggest difference between the two is in who — or what, as the case may be — is providing the financial advice.
In general, financial advisors are people who provide personal, one-on-one advice to clients, while robo-advisors are largely digital investment advisors that rely on algorithms and computer data to drive customer investments. There are also significant differences in the costs of each, their investment approaches and the type of services offered.
Robo-advisor vs. financial advisor: What’s the difference?
Robo-advisor
- Digital investment advisor, with limited direct human interaction
- Fees are lower on average than human advisors
- Your funds are generally invested in broad-based exchange-traded funds (ETFs)
- May have lower account minimum requirements than traditional advisors
Financial advisor
- Human investment advisor
- Fees are higher, on average, than for robo-advisors
- May offer a wider range of investment options
- May have higher account minimum requirements than robo-advisors
Robo-advisors and financial advisors both ultimately provide the same basic service: professional recommendations about how to best invest your money. There are some distinct differences, however. Robo-advisors tend to offer more general, less personalized services limited to investment advice, while traditional financial advisors often offer additional services and a human touch. Here are some other ways the two types of advisors differ:
1. Robo-advisor vs. financial advisor costs
In general, robo-advisors are less expensive than financial advisors because they usually provide more limited services and less direct human interaction in exchange for lower fees. On average, the fee for a balance of $50,000 is 0.36% with a robo-advisor — or about $180 per year. That’s considerably lower than the cost for human advisors, who charge an average fee of 1.17% — or $585 for that same balance.
2. Robo-advisor vs. financial advisor minimums
In many cases, robo-advisors offer accounts with lower minimum account balance requirements than traditional financial advisors. Many top-rated robo-advisors have no account minimum requirement or a nominal one (think $10 or less), though minimums for robo-advisors can be as high as $100,000. The account minimums for traditional financial advisors vary more widely and are generally higher. While some advisors have $0 account minimums, other people only take on clients with at least $10 million in assets, and there is a lot of variation in between.
3. Robo-advisor vs. financial advisor investment approach
When evaluating the two options, many people wonder: “How do robo-advisors work?” It may seem a bit intimidating to remove the human factor from financial advice, but that works well for many people. Robo-advisors generally base your investment approach on a questionnaire you complete online that evaluates your goals, tolerance for risk and other factors. Then, using an algorithm, the company builds a portfolio for you, usually constructed of ETFs or similar investments.
A financial advisor, on the other hand, offers more personalized services. The advisor may meet with you in person or over the phone to evaluate your risk tolerance, goals and other factors to determine the best makeup of your portfolio. While your portfolio may contain ETFs, human advisors typically provide a variety of other investment offerings as well. Financial advisors are also more likely to offer additional services such as budgeting, education planning, retirement planning and creating plans to pay down debt.
4. Robo-advisor vs. financial advisor returns
In general, various studies estimate that professional advice may result in an increase in a portfolio’s value of between 1.5% and 4%. However, returns aren’t guaranteed for either type of advisor. If your money is invested in a diverse portfolio of assets that aligns with your goals, rather than trying to “beat the market,” your average returns are likely to be similar in the long-term with a robo-advisor or a financial advisor. While you can compare the returns of various advisors from previous years, that doesn’t mean you can bank on the same returns in ensuing years due to market volatility.
Pros and cons of robo-advisors vs. financial advisors
When it comes to choosing between a robo-advisor and a traditional advisor, it’s important to weigh the pros and cons of each. Both types of advisors can help you invest your money with a goal to grow it with interest over time. Unless you’re highly educated about investing and have the time and dedication to research and manage your funds yourself, advisors are helpful. Which one stacks up better for you, however, will depend on your own unique circumstances and personal preferences.
Robo-advisor pros and cons
In general, robo-advisors are simple to use and great for beginner investors who want to jump into investing without too much hassle or commitment. But there are pros and cons of robo-advisors, including the following:
Pros
- Low fees. Due to the lack of — or at most, limited — human assistance, the fees for robo-advisors are typically lower than those of traditional advisors. The less you spend on fees, the more money you can invest.
- Ease of use. In just a few minutes, after providing some basic information and answering questions online, you can start investing with a robo-advisor. Managing your account also is easy, since you can access it anytime online or via an app.
- Low barrier to get started. Some traditional financial planners have minimum account balances that range from thousands to millions of dollars. Many robo-advisors have $0 minimum account balance requirements or nominal ones, making them a great option for beginner investors who may not have a lot of money to get started.
Cons
- Potentially limited services. In general, robo-advisors limit their services to investment advice, unlike traditional advisors who may offer an array of services, such as help with budgeting, retirement planning, financial planning and more. Some robo-advisors do provide additional services, but they often charge an additional fee.
- Lack of human interaction. If you like a personal feel and want to get to know your advisor on a one-on-one basis, then a robo-advisor probably isn’t for you. To some people, using a robo-advisor may feel cold, impersonal and even unsettling to think of an algorithm being in charge of their money.
- Limited trading and investment options. In general, robo-advisors tend to invest customer funds in ETFs, which is a good way to build a diversified portfolio. If, however, you want to invest in other products or you want to trade individual stocks, you’re less likely to be able to do so with a robo-advisor.
Financial advisor pros and cons
A traditional financial advisor offers the human touch some investors may prefer. They often offer a wide range of services in addition to basic investment advice, which may be helpful depending on your personal circumstances. There are, however, pros and cons all investors should consider before choosing a financial advisor:
Pros
- Personalized service. Traditional advisors typically offer clients the option of sitting down with their advisor face-to-face on a regular basis. This is important to some investors who want to establish a personal relationship with the person managing their money.
- Full array of financial services. Many financial advisors offer additional services in addition to just building and managing portfolios. They often offer services such as retirement planning, estate planning, goal planning and more, which may be important to you.
- More investment options. While a traditional advisor may recommend ETFs as part of your portfolio, many also offer other investment options. Also, if you want to buy or sell individual stocks, commodities, currencies or other types of assets, your planner can help you do so.
Cons
- Fees. The biggest downside to using a financial advisor may be the fees. Those fees for traditional financial advisors tend to be higher than robo-advisors, and it’s important for clients to understand the full scope of fees they’ll be paying and how it may affect their bottom line.
- Account minimums. While there are some traditional financial advisors that don’t require a minimum account balance, many do. Some of those minimums can be quite high (up into millions of dollars), which is prohibitive to some investors.
Should I use a financial advisor or a robo-advisor?
You can’t go wrong choosing either a financial or a robo-advisor, since either way, you’re investing money that will likely grow over time and help you build a solid financial future. However, depending on your unique circumstances and preferences, one may be a better choice for you.
Beginning investors or those people with limited funds may find a robo-advisor to be the best bet, since fees and account minimum requirements are typically lower. Those people investing with greater sums of money or who want to have more choices and more individual attention paid to their investments, will likely be more satisfied using a financial advisor. It’s also important to consider the significant differences between individual robo-advisors and traditional advisors.
If you’re torn between the two types of advisors, another option is an online financial planning service, which has a mix of the benefits of robo-advisors and human advisors. These services, along with hybrid models from robo-advisors, offer a bit more human interaction, but it’s mostly done through phone calls, e-mails or live chats, rather than the in-person assistance typically offered by traditional advisors.
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This article originally appeared on LendingTree.com and was syndicated by MediaFeed.org.
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Investing for beginners: Basic strategies to know
As an investor, you are unique. And as you start building your portfolio, there are many strategies you can draw upon to help you achieve your personal financial objectives. Which you choose will depend on your needs and the goals you are trying to accomplish.
Related: Asset allocation for beginners
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Say you’re in the market for a new pair of shoes. You’ll likely want to choose something that will last a long time, is a comfortable fit and doesn’t leave you wondering whether you made a mistake when you bought them.
The shoes should also fit your individual needs — are they for long-distance running, for work, for going out at night?
In many ways, choosing an investment strategy is like shopping for the right pair of shoes. You need one that fits your personal goals, whether those goals are saving for a down payment on a house, a child’s education, or retirement.
And you need a strategy that will be comfortable for you to pursue in the long-term. You don’t want to be tempted to switch strategies frequently, potentially upending your financial plan.
Ultimately, the best strategy (or mix of strategies) is the one that works for you. Here’s a look at some of the fundamental strategies that you may want to consider as you start to build out your investment portfolio for the first time.
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An investment strategy that splits a portfolio among asset classes — including stocks, bonds and cash — asset allocation helps strike a balance between investment risks and returns.
Each of the assets classes above behaves differently under different market circumstances, which means each has its own risk and return profile. For example, stocks tend to offer the potential for the highest returns. They can also be volatile, which means in addition to high highs, they may experience low lows.
Cash, on the other hand, tends to be extremely stable. The money in your savings account isn’t likely to go anywhere and might even be insured by the federal government.
Yet, the trade-off for that stability is the fact that savings accounts or other cash equivalents, such as certificates of deposit, offer relatively low returns, typically between 0.01% and 3% APY.
The proportion of each asset class that investors hold is related to their personal goals, time horizon and risk tolerance. Time horizon is the amount of time an investor has to invest before they achieve their goals, and risk tolerance is an investor’s willingness to lose some of an investment in exchange for potentially greater long-term returns.
Asset allocation might shift over time. An investor in their 20s saving for retirement might have a portfolio made up of mostly stocks. Stocks could offer the greatest potential returns, and with 40 years before the investor might need the money, they may have plenty of time to ride out any downturns in the stock market.
A person who has already retired and needs much more immediate access to their cash may hold more fixed-income investments, like bonds, which are less volatile and therefore less likely to experience hard downturns at the time the investor needs them.
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One way to manage risks in a portfolio is through diversification: building a portfolio with a broad mix of investments across assets. Essentially, diversification can help investors avoid putting all their eggs in one basket.
Imagine for a moment a portfolio invested in just one oil stock. If the price of oil goes down, the entire portfolio suffers.
Now imagine a portfolio that holds stocks from all sectors, in companies of all sizes from all around the world. Not only that, but the portfolio holds a variety of bonds and even other investments like real estate.
Similar to asset allocation, the idea here is that these different investments will behave differently during changing market conditions. For example, U.S. stocks may not perform the same as European stocks, and energy stocks may not perform the same as medical company stocks.
With a diversified portfolio, as market condition changes — such as a drop in the price of oil — one group of investments may suffer while another may not, thereby spreading out risk.
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Your portfolio can change over time. During a bull market, you may find your stocks are performing well and that they now make up a much greater portion of your portfolio than they did before.
Remember that your portfolio is balanced based on your personal goals, time horizon and risk tolerance. So when there is a shift in holdings, investors may want to buy or sell assets to bring their portfolio back in line with their planned asset allocation.
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Tax efficiency is a measure of how much of your return stays with you and how much ends up going to the government. Keeping an eye on taxes can be an important part of maximizing your investment returns.
The first step in building a tax-efficient portfolio is to understand where the investments — whether in taxable, tax-deferred, or tax-free accounts — will be held. Taxable accounts include brokerage accounts, and income from these accounts may be subject to long- and short-term capital gains tax and other taxes.
Long-term capital gains tax is a tax treatment applied to investments that have been held for a year or more. Short-term capital gains tax is applied to investments that are held for less than a year and are pegged to an investor’s tax bracket.
Investors looking to minimize their taxes might want to hold on to investments for more than a year to be subject to the longer long-term capital gains rates.
Tax-deferred accounts, such as 401(k)s and traditional IRAs, allow investments to grow tax-free as long as they remain in the account. Investors fund these accounts with pre-tax dollars, and withdrawals made after age 59½ are subject to regular income tax.
Tax-free accounts, such as Roth 401(k)s and Roth IRAs, are funded with after-tax dollars, but investments inside the account then grow tax-free. When investors make qualified withdrawals from these accounts, they pay no additional taxes.
As a general rule of thumb, tax-efficient investments, such as regular stocks, may be held in a taxable account, while investors may want to hold inefficient investments, such as taxable bonds, in accounts that have preferential tax treatment.
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Dollar-cost averaging is a process by which investors invest on a regular basis, making purchases regardless of price. For example, an investor might choose to invest $100 a month in an index fund that tracks the S&P 500.
The share price for that fund will likely vary from month to month, though the amount of money the investor uses to buy shares does not. By design the investor buys fewer stocks when they are priced high and more when they are priced low.
This strategy might help investors mitigate buying high and selling low. And because investment is done on a regular schedule with a set amount of money, this strategy is one way for investors to avoid emotional investing.
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Investors who choose to use a buy and hold strategy will typically buy stocks and hang on to them for the long term, regardless of short-term market movement. Buy and hold investors believe that they will achieve some kind of return in the future despite fluctuations in the market on a short-term basis.
Fluctuations in the market are a normal occurrence, but investors may still get nervous and want to sell their stocks at the first sign of a downturn.
However, this tendency can work against investors, as selling a stock locks in any losses they may have experienced and means they could miss out on any subsequent rebound in price. A buy and hold strategy might help curb this tendency.
What’s more, the buy and hold strategy could help investors minimize fees associated with trading, which might help boost the overall return of the portfolio.
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Fundamental analysis is a strategy that can help investors choose specific stocks to buy. When practicing fundamental analysis, investors look at public data like financial statements, revenue, earnings, future growth and profit margins as well as broader economic factors when choosing a stock.
Fundamental analysis attempts to look at everything that affects a security’s value, including macroeconomic factors like overall market conditions and industry conditions and microeconomic factors such as company management.
Investors hope that a thorough examination of these factors can help them arrive at an intrinsic value for the stock. The price at which the stock is actually trading may be above or below this value, and by comparing this value with the current price, investors could determine whether or not it’s a good time to buy.
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Unlike fundamental analysis, technical analysis does not try to identify an intrinsic value of a particular investment. Technical analysts believe that a stock’s fundamentals are already factored into the price of the stock so do not require individual attention.
So, when using this strategy, investors try to identify good investments by looking at statistical trends. For example, investors may look at factors such as price movement and trading volume. By identifying patterns and current trends, investors hope to be able to predict future patterns and trends.
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Value investing is a strategy that makes use of fundamental analysis. The basic idea behind this style of investing is that investors only buy stocks that are priced lower than their actual value and hold onto them for the long-term, or at least until they rise above the investor’s price target.
In other words, these investors are looking to buy stocks that are mispriced or priced at a “discount.” If an investor buys a stock at a lower price than they believe it is actually worth, chances may be good that the price of the stock will rise before the investor sells it.
Before buying any asset, investors should be sure to do their due diligence, learning as much about it as they can. In some cases, investors can lean on the expertise of others. Rather than try to identify values of stocks themselves, investors can buy mutual funds, index funds, or exchange-traded funds (ETFs) that hold value stocks that have already been identified by professional fund managers.
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While value investors are looking for stocks that are priced less than they are worth, growth stock investors put much less emphasis on the current price.
They are focused on stocks that are likely to increase in value in the future, more so than other stocks in their industry or the market as a whole.
Growth investors tend to focus on young companies that have a lot of growth potential, companies in quickly expanding industries and those that make use of new technologies and services.
There is no real formula for what to look for when identifying growth stocks. However, investors looking for growth opportunities might want to look at companies that have strong historical earnings growth in the recent past. Investors might also look at forward earnings growth.
Publicly traded stocks must make earnings announcements on a regular basis, and analysts will make earnings estimates shortly before these announcements are made. These numbers can help analysts approximate the fair value for the company.
Once again, investors can leave the analysis up to professionals and may choose to invest in mutual funds, index funds, or ETFs that invest in growth stocks. Investors interested in taking a hands-off approach through investing in funds may consider an automated investing account to help them build a portfolio.
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Your life is not static, and your goals and financial needs will change. For example, you may change careers, get married, have children, decide to retire early or decide you want to work longer than you had planned. Each of these milestones can affect your goals and how much money you need to save.
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This article originally appeared on SoFi.com and was syndicated by MediaFeed.org.
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Tax Information: This article provides general background information only and is not intended to serve as legal or tax advice or as a substitute for legal counsel. You should consult your own attorney and/or tax advisor if you have a question requiring legal or tax advice.
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