Should I invest in a Robo-Advisor? | Smart Switch: Personal Finance

A robo-advisor is a digital platform that uses computer algorithms to create and manage a diversified portfolio based on your risk tolerance, financial goals, and other personal factors. It also automatically rebalances your portfolio based on market conditions and your investment goals. While that sounds great, a robotic advisor can come with some serious risks. Before you invest, you need to weigh the pros and cons.

Robo-advisors continue to grow in popularity. According to a study by the international consulting firm Deloitte, assets managed with the support of robo-advisors may grow to more than $16 trillion by 2025, about three times more than BlackRock, the world’s largest asset manager. In fact, robo-advisors can offer several features that would appeal to investors looking for a hands-off, no-hassle approach.

costsNote: A human financial advisor may charge an Assets Under Management (AUM) fee of 1% or more. Robo-advisor AUM fees can range from 0% to 0.40%. To put that in perspective, a 1% annual AUM fee on a $10,000 investment is reduced to $100. A 0.25% AUM fee on a $10,000 investment is just $25 a year.

Diversification: Most robotic advisors provide you with a questionnaire about your financial goals, risk tolerance, and more. An algorithm uses these responses to recommend a combination of investments.

automatic rebalancing: Market conditions can alter your investment mix and may leave you overly focused on one asset class, leaving you exposed to significant risk should you face a downturn. When this happens, the robotic advisors rebalance your portfolio back to its original investment mix, sometimes selling the investments that went up and using the profits to buy the ones that went down.

Despite the hype, robotic advisors do have their potential drawbacks:

Hidden costs: Even though robotic advisors generally charge much less in management fees than traditional advisors, they still eat up your money expense ratios or commissions charged for the funds in your portfolio. Some may argue that you can simply open a discount brokerage account and invest in these funds yourself, avoiding the AUM fee entirely. There are many online asset allocation tools that can recommend a personalized investment mix, similar to how an automated advisor uses a questionnaire.

fluctuating ratesNote: Some robotic advisors may increase your AUM fees as your balance increases. The more you invest with them, the more they take away.

Little or no human interaction: If you have a premium plan or pay an additional fee, some auto advisors give you access to financial planners that can help you meet other financial goals, like paying off high-interest debt. But many plans don’t offer access to human advisers at all. For those looking for a hybrid service that allows them to speak to a human advisor whenever they want, their options may be limited.

If you’re comfortable handing over investment management to an advanced algorithm and professionals, accepting limited investment options for a potentially low fee, then a robotic advisor may be for you.

But if you’re experienced or have a little time to develop your investment acumen, building and managing your own portfolio may be a better option.

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Fool’s collaborator, Javier Simón, does not hold any financial position in any of the companies mentioned. The Motley Fool has a disclosure policy.