Traditionally, people rely on financial advisors to invest their wealth. Few of us have the time, desire, or insight to choose our own investments and maintain a balanced portfolio. So we outsource it. Financial advisors charge us a 2-3% fee and manage our money based on our risk tolerance and goals. That all sounds great. But what if you could replace your financial advisor with a software platform? Over the last few years, robo-advisors, or automated online investment platforms, have gained popularity. These online platforms use software algorithms to determine and maintain the right portfolio strategy for each person.
Besides the novelty, why are robo-advisors so popular? Put simply, they are inexpensive. They can charge a low fee because they are cheap to run. Think about it. A financial advisor can only assist so many clients before reaching capacity. A robo-advisor can achieve much greater scale. Once the software algorithm is created, it doesn't take much to keep it running for millions of people. Most robo-advisors charge 0.25%-0.5% of assets managed, while a financial advisor may charge eight times that! A few percentage points may seem low, but you pay these fees every year, and they increase as your wealth grows. Fees can have a material impact on your long-term returns.
Another reason robo-advisors are so popular is that their minimum account size is low and often nonexistent. This makes them perfect for new investors. On the other hand, financial advisors often require a minimum balance of $200,000 or more. Remember, you pay financial advisors a percentage of the assets they manage for you. The more money you give them, the more money they make. Managing a small account just isn't worth their while. However, a robo-advisor can give a new investor access to investment management at pretty much any size.
Some people are still not fully on board with the whole robot thing. They want a personal relationship with their financial advisor and a flesh-and-blood contact who understands their goals. And it's a fair point! However, there's no denying that robo-advisors offer a compelling value proposition, especially to new and young investors.