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Is a Robo-Advisor Always the Most Cost-Effective Choice?

Author: Matthew Harris

The robo-advisor is the shiny new investment management tool. It is almost perfect for some investors. But let's pull back the curtain a bit and examine the true costs of a robo-advisor (or digital/automated advisor). Costs can be measured in dollars as well as in personal and emotional expenditures.

Services May Not Fit Needs

Given their one-size-fits-all approach, most, although not all robo-advisors, fit you into a pre-designed investment portfolio. In general, the robo deals with your investments. If you need a comprehensive planner who deals with your tax, estate, succession and business planning you may pay a cost in lost services or additional expense for the assistance you need if you employ a robo-advisor manager. (For more, see: Pros & Cons of Using a Robo-Advisor.)

Murky Fees

Robo-advisor fees and services aren't uniform. There are some robo-advisors with clearly explained fees and others with more complex obtuse fee structures. Several robo-advisors offer a limited financial advisor with their plans. Thus, consider that both robo-advisors and financial advisors have within category differences.

Most robo-advisor's fee structures begin with a percent charge for amount of assets under management (AUM). In general, regardless of the AUM fee, robos have additional charges. Every mutual and exchange-traded fund (ETF) has an expense ratio. For a plain vanilla index ETF, such as Vanguard's Total Stock Market Index ETF (VTI), the expense ratio is a meager 0.05%. Yet, there are other index funds with higher expense ratios such as the Rydex S&P 500 Class A (RYSOX) with an annual fee of over 1%. I'm not implying that a specific robo-advisor has RYSOX in its arsenal, only that it's important to understand the cost of a fund's underlying management fees. At a minimum, the robo-advisor will have the AUM fee plus the underlying fund management charge from the fund company. When evaluating a robo-advisor, make certain to understand all of the costs, not only the plan's management fee. (For more, see: Are Robo-Advisors Becoming More Human?)

Limited Portfolio Options

Most robos offer a limited number of portfolio options. The robo-advisor chooses a certain number of mutual funds or individual stocks in which to invest. Next, the firm chooses a limited number of asset allocation choices from conservative to aggressive. The investor is then assigned a particular portfolio based upon a short time horizon and risk tolerance quiz. This is usually a very cursory look into an individual's true risk tolerance and time horizon.

For example, Harold may need a portion of his investments in 10 years when Junior starts college and another portion in 25 years when he expects to retire. Most robos aren't equipped to handle these types of differing time horizons. The consumer cost is that the asset allocation may not be appropriate for you. If it's too aggressive and the markets are in a down cycle at the time the money is needed, Harold may be forced to withdraw funds at an inopportune time, such as after a market decline, thereby decreasing his total net worth. (For more, see: Can You Really Trust a Robo-Advisor?)

Excluding the Big Picture

You may have several investment accounts such as a 401(k) at work, your spouse's 403(b) plan, a Roth IRA and a taxable brokerage account. Unless the robo-advisor is managing all of those accounts or has the ability to view them, your asset allocation may be out of whack.

Here's an example. Janice and Dean have $100,000 net worth spread across 4 accounts:

Janice and Dean's Investment Portfolio



Investment Holdings

Janice 401(k)


Stock and Bond Funds

Dean 401(k)


Stock Funds

Janice Roth IRA


Stock and Bond Funds

Joint Brokerage Account


Individual stocks, Stock and Bond Funds

If Janice and Dean turn their joint brokerage account over to a robo-advisor for management without also including information about their other assets, then their total asset allocation won't fit their risk tolerance or time horizon. Additionally, your total investment portfolio could end up either more aggressive or more conservative without a complete picture of all of your investment assets. This could have long term financial and emotional costs. (For more, see: Are Robo-Advisors a Good Idea for Young Investors?)

No Long-Term Track Record

The robo advisory field is quite new. Thus, few have a long time horizon within which to view their returns. There could be a cost of investing in a sub-optimal program due to a limited picture of the robo-advisors' returns. Further, their tax-loss selling or rebalancing approach may not play out as planned.

No Human Touch

Investors are notoriously fearful and have a history of making self-handicapping decisions. For example, it's not uncommon for the investor to get scared after a market drop, panic, and sell their investments at a low point. After the markets move back up, this investor has no money in the markets and doesn't make up the gains that holding on during market volatility would have allowed. Investors may make poor and expensive decisions without someone to talk them off the ledge or save them from themselves during volatile markets. This can cost the investor thousands of dollars that may not have been lost had the individual had a financial advisor with whom to consult.

The Bottom Line

If the robo-advisor doesn't fit your needs, the lower fee structures can conceal greater costs. For some investors, the financial planner advisory fees are well worth paying in the long run for the breadth of services that a flesh and blood financial advisor offers. Whichever financial management approach you choose, do your homework and understand what you're paying and the benefits and services you receive. (For related reading, see: Is an Online Financial Advisor Right for You?)

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