Investing for retirement can seem overwhelming and confusing. Where do you start? How do you choose your investments? What steps can you take to meet your financial goals?
Don’t stress. There’s a simple way to start investing for retirement, and even put most of your investing decisions on autopilot using technology — more specifically, a robo-advisor.
What is a Robo-Advisor?
Robo-advisors are fully automated online investment platforms that use algorithms and sophisticated software to create and manage an investment portfolio. Unlike working with a financial advisor in real life, robo-advisors require little to no human interaction since they use technology to simplify and automate the investing process. As such, investing with a robo-advisor tends to cost a lot less.
You’ve probably heard of robo-advisors before, but maybe you’ve never considered using one for your own investing needs. Think of them as a sort of “virtual assistant” for investing that can help you start building wealth for retirement with minimal effort.
Sure, it may seem like a challenge to prioritize planning for retirement when you’re paying off debt, but robo-advisors can help make it easier for you to start socking away some money and put those savings to work for your post-working years.
How Do They Work?
In a nutshell, robo-advisors automatically invest your savings and manage your investments. To start, you’ll answer a series of questions about your age, current financial situation and savings (if any), accumulated debts, how much investment risk you can stomach (aka your “risk tolerance”), long-term financial goals (i.e., retirement), and timeline (i.e., if your goal is saving for retirement, that might be 30-35 years). Then, the robo-advisor runs your responses through its algorithm and recommends a portfolio.
These portfolios are generally made up of low-cost exchange-traded funds (ETFs), which are investment funds that track a selected index. Indexes can be as simple as tracking the S&P 500, or more focused, like only investing in companies that operate in the gold mining industry. Over time the robo-advisor’s software regularly makes changes to your portfolio to make sure your investments stay aligned with your risk tolerance and goals.
Some robo-advisors allow you to open an account with as little as $1, while others require you to invest as much as $10,000 to start. Pay close attention to the minimum start-up requirements and select the option that makes the most sense for you.
Not all robo-advisors offer the same services. Some have a limited number of exchange-traded funds inside of their portfolios. Others automatically make trades that can help lower your tax bill, a process called tax loss harvesting. Some offer additional planning tools that can project how your money might grow over time, for example. Some interact with you almost exclusively online, and others even offer access to a human financial advisor for investors who want more hands-on assistance and/or financial planning.
How Much Do They Cost?
Robo-advisors generally charge service fees. Some levy a fixed monthly fee—usually somewhere between $15 to $200, depending on your portfolio size. Others charge you based on a percentage of your assets, and those fees can range from about 0.2% to 0.5% each year. So for example, if your balance was $5,000 and the service fee was 0.5%, you’d pay $25 a year.
In addition, you’ll likely pay a separate fee for the investments used by the robo-advisor. For example, exchange-traded funds have expense ratios that are usually taken out of the funds’ assets before the returns are allocated to investors.
Pros and Cons
If you like the sound of automating your retirement investments with a robo-advisor, you’re not alone. Lots of people, especially younger generations, are using robo-advisors to make their financial lives easier. In 2017, the assets managed by these online investment platforms reached $222 billion — double 2016 levels.
To be sure, robo-advisors can help make it easier for you to invest and grow your wealth for the future. Like anything, though, they have some benefits and drawbacks.
Easy set-up and convenient access: You can generally set up and fund an account online in minutes. After the initial set-up, you can access your account information 24/7 from your desktop, tablet or smartphone.
Low-cost investment options: Robo-advisors typically offer quality portfolios, low-cost investments, and inexpensive portfolio management. They have fewer overhead expenses such as office space and staffing costs, so they’re able to pass those savings on to you. Again, typical robo-advisory fees range from 0.2-0.5% of total assets per year, compared to 1-1.5% of the usual asset management fee charged by financial advisors. Upside: the savings achieved by investing with a robo-advisor could really add up when compounded over time.
Simplified investing and less stress: Robo-advisors’ software automates the entire investing process, including selecting a diversified mix of investments and monitoring them for you. You don’t have to adjust your portfolio, log in and make trades, or worry whether or not a financial professional is acting in your best interest. Robo-advisors do it all you.
Avoid costly investing mistakes: Investing can be emotional, which sometimes causes investors to make impulsive decisions that compromise their long-term goals. In fact, research shows that investors’ behavior is one of the biggest reasons for poor investment performance. Robo-advisors’ software takes the emotion out of investing, eliminating the cost of human error.
No human touch: While a lack of human emotion can be a benefit in investing, it can also be a disadvantage. Unlike a real-live human financial advisor, robo-advisors can’t guide you through tough investing decisions or knee-jerk reactions to turbulent markets or create a holistic financial plan for you that goes beyond your investment strategy.
Lack of a “life happens” factor: When you experience a major life change, such as getting married or starting a family, you can talk to a human advisor about its potential impact on your financial life. Robo-advisors can’t necessarily account for such changes. Even if you log in and manually alter your profile to reflect your life change, a robo-advisor still may not update your portfolio accordingly.
You don’t get truly personalized investment advice: Robo-advisors’ software and algorithms do the best they can to create an ideal portfolio based on your responses to their questions. However, they can’t make totally customized recommendations like a human advisor who knows “real-life” you and is thus able to create a strategy for you based on your entire financial picture and goals.
Volatility still happens: At their core, robo-advisors aren’t any better than humans at avoiding investment losses due to market downturns. So while robo-advisors’ software takes emotion out of investing, they can only do so much to protect us from our own rash behavior. In other words, they can’t talk you off a ledge or coach you to stay the course in times of market uncertainty.
Is a Robo-Advisor Right for You?
The short answer is, it might be. Generally, robo-advisors can be a good fit for younger investors who are just getting started, who don’t have complicated personal financial situations, and who are looking for a low-cost platform to help them invest.
They can also be an appealing option if you don’t want to hire a financial advisor or don’t have enough savings yet to do so, or if you’re a do-it-yourself investor, but don’t want to be directly involved in the day-to-day portfolio management. Or maybe you’re insanely busy with life, your job and raising a family, and you just don’t have time to research and select your retirement investments on your own.
If any of those sounds like you, and if you’re looking for a simple, technology-driven, low-cost way to start saving and investing for retirement, a robo-advisor may be just the droid you’re looking for.