The other day, I had a friend reach out and ask about my thoughts on robo advisors. Robo advisor platforms have been gaining immense popularity among young professionals early in their savings journeys. This is a discussion about the role of robo advisors, how they support investors, and when they may fall short.

The Role of Robo Advisors

A colleague of mine once wanted to host a debate between a successful financial professional and the founder of a robo advising platform. To my colleague’s surprise, the founder responded by declining the debate and saying that robo advisors are not intended to outperform or replace advisors, but rather to offer an option to investors who don’t meet advisor minimums.

Here are some of the biggest mistakes I see investors make when they go it alone:

  • Lack of diversification
  • Inappropriate allocation for risk tolerance level
  • Too high of cash concentration

Robo advisors tend to solve these issues. Most of the platforms have people go through a risk tolerance questionnaire or ask them how much risk they’d like to take on. The platform then puts the investor in a portfolio of funds, which are diversified baskets of stock or bonds, in accordance with the investor’s selected risk level. Oftentimes, they’ll also offer automatic portfolio rebalancing, which will make sure that your portfolio stays allocated to your risk tolerance even during major swings in performance.

All these services are often offered at a nominal price, which is usually lower than what a human advisor would charge. From a risk and return standpoint, having a robo advisor can better serve many investors than attempting to choose individual stocks, day trading, trying to time markets, or trying to pick sectors.

Where Robo Advisors Fall Short

Robo advisors fall short of qualified human advisors in several ways. Among most platforms, the main service offered is portfolio management, which is a small part of what a qualified human advisor does.

Here are the additional roles that many qualified human advisors take on.

Behavioral Coaching

Behavioral coaching is, according to a Vanguard study on the value of advisors, the largest value add of a human advisor. Let’s go through two examples.

You’re an investor in 2008 and your portfolio went down 40% from the market’s peak. All of your friends are telling you that the market is going to continue to slide, and this is going to be the next Great Depression. You move all your investments to cash, missing out on the full recovery over the next couple years.

You’re an investor at the beginning of 2023 and you consider yourself aggressive, but you’ve never seen interest rates this high. You lock all your investments in a 1-year bank certificate of deposit getting 4.5%, missing out on more than 20% in stock market returns over that year.

In both instances, a qualified financial professional would have talked you through your goals and coached that you invest consistently with those goals, not with what’s happening in the market.

Accountability

If you are working with a qualified human advisor, you’re likely on a review schedule with them. Whether it’s annually, semi-annually, or quarterly, you’re getting together and talking through what’s happening in your life, your progress toward goals, changes in your goals, your tolerance for risk, the market environment, changes in laws, and portfolio performance.

This is where a lot of issue-spotting happens before it develops into a full-blown problem. This is also where an advisor can act as a partner in tackling new financial goals, such as college planning for a newborn, selecting benefits for a new job, tax management for a new business, or budgeting for a new expense.

With a robo advisor, you don’t have that level of accountability. There’s not a person sitting down with you to discuss your life and answer your questions. You could set up an account and never look at it again. You could forget what the purpose of the account was in the first place.

Choosing Investment Vehicles

Asset location is almost equally important to asset allocation. Asset location refers to the vehicle holding your investments and the associated tax wrapper.

Examples of investment vehicles include traditional IRAs, Roth IRAs, SEP IRAs, 401(k)s, 529s, Donor Advised Funds, life insurance, and many more. Each has instances where they are appropriate and provide taxation benefits, but they also all have limitations and require a thorough understanding of your picture to determine if the vehicle is best for you.

Advanced Customization

Some examples of advanced customization human advisors may offer include:

  • Excluding specific stocks from your portfolio
  • Making sure certain stocks are included
  • Taking loans from stock holdings
  • Harvesting tax losses to write against tax gains
  • Access to specialized investments like exchange funds and privately held companies
  • Trust and estate planning
  • Mapping out unique income sources and goals

Conclusion

Robo advisors were created with the express goal of offering portfolio management to investors who cannot meet advisor minimums. They solve a lot of basic investing mistakes and provide new investors with diversified portfolios. When investors want to make sure they’re defining and meeting their financial goals, it may be time to engage a qualified human financial professional.

This informational and educational article does not offer or constitute, and should not be relied upon as tax, legal or financial advice. Your unique needs, goals and circumstances require the individualized attention of your own tax and financial professionals whose advice and services will prevail over any information provided in this article. Equitable Advisors, LLC and its associates and affiliates do not provide tax or legal advice or services. Equitable Advisors, LLC (Equitable Financial Advisors in MI and TN) and its affiliates do not endorse, approve or make any representations as to the accuracy, completeness or appropriateness of any part of any content linked to from this article.

Cicely Jones (CA Insurance Lic. #: 0K81625) offers securities through Equitable Advisors, LLC (NY, NY 212-314-4600), member FINRA, SIPC (Equitable Financial Advisors in MI & TN) and offers annuity and insurance products through Equitable Network, LLC, which conducts business in California as Equitable Network Insurance Agency of California, LLC). Financial Professionals may transact business and/or respond to inquiries only in state(s) in which they are properly qualified. Any compensation that Ms. Jones may receive for the publication of this article is earned separate from, and entirely outside of her capacities with, Equitable Advisors, LLC and Equitable Network, LLC (Equitable Network Insurance Agency of California, LLC). AGE-6417195.1 (03/24)(exp.03/26)

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