Robo advisors are automated investment services that provide low-cost portfolio diversification and automated money management for people who want to invest passively without hiring a financial advisor. They use algorithms to determine your risk profile and construct your portfolios based on that information. But can one lose money with robo advisors?
You can potentially lose money through robo advisors. Generally, no investment offering can guarantee results. Nonetheless, robo advisors offer an excellent way to start investing without hiring an expensive financial advisor or paying commissions on full-service investment accounts.
In the rest of this article, I will describe the ways you could lose money with robo advisors and provide insights into choosing one that’s a good fit for your portfolio. Read on for more insights and the pros and cons of these automated services.
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3 Ways You Could Lose Money With Robo Advisors
Robo advisors rely on algorithms to construct your investments based on your risk profiles and preferences, but not all algorithms are created equal. Some robo advisors may construct portfolios that are more mixed and volatile than others. While some algorithms can cause your portfolio to grow more quickly, they might also be riskier in the short term.
Here are some of the ways you could lose money with a robo advisor:
Poor Allocation of Assets
Robo advisors usually allocate funds based on your risk profile and preferences.
For example, if you’re extremely risk-averse and prefer a conservative portfolio, the robo advisor might recommend that you hold more bonds than other, less conservative investors.
However, while some algorithms may be more accurate than others, there is no guarantee that they will always predict the proper amount of risk for your portfolio.
If you do not receive an appropriate allocation of assets for your level of risk tolerance, it’s possible to lose money. For instance, if you hold a larger number of equities than bonds in a bear market, the value of your portfolio could drop dramatically.
Volatile or Poorly Managed Portfolio
The best robo advisors monitor and manage their clients’ portfolios to keep them on track and consistent with investors’ preferences.
However, there is no guarantee that they will always do this effectively.
A robo advisor’s performance is measured by its ability to manage risk and avoid loss, which means it might be more willing to make trades than your average investor.
A robo advisor can potentially lose money through poorly managed portfolios, especially if it takes on too much risk in search of higher returns.
A good robo advisor will not make trades unless they are reasonably expected to increase value over time, but you should always keep in mind that no investment is completely risk-free.
High Fees
Robo advisors offer low fees for automated money management, which makes them appealing to investors of all types.
However, not all robo advisors are created equal; some charge higher fees than others.
Some robo advisors may charge per month, while others may charge annually. Depending on your portfolio size and the types of investments in it, you could pay more than with other services.
To avoid losing money through high fees, you should always read the fine print to determine how much you will be charged for management and what services are included.
Robo advisors vary in terms of pricing and you should always compare fees with other services before making any investment decisions.
The Potential Risks of Using Robo Advisors
While robo advisors are great for individuals who want to invest on their own but lack the time or resources to do it themselves, they still carry some risks.
If you use a robo advisor, there is no guarantee that your portfolio will perform as expected. If you prefer a high level of risk and would like to invest accordingly, you might end up with a portfolio that’s too conservative for your needs.
Similarly, if the robo advisor makes bad calls about how to manage your investments (such as allocating funds based on incorrect assumptions), it could cause major problems for your portfolio.
A poorly managed portfolio focused on aggressive trading is likely to lose money rather than generate the returns you are looking for.
Pros of Using a Robo Advisor
As mentioned, robo advisors typically charge lower fees, offer guidance, and are transparent.
Here’s a rundown of the benefits of using these automated investment services:
Low Costs and Minimum Investment Thresholds
Robo advisors keep fees low, and in most cases, their fees are considerably lower than comparable human financial advisors.
Similarly, the minimum investment threshold with robo advisors is only a fraction of what one would need for hiring a financial advisor.
For instance, Bank of America typically requires customers to deposit at least $25,000 to qualify for a private financial advisor. However, this requirement reduces drastically to $5,000 when one chooses a robo advisor.
Guidance
Human financial advisors are known for providing guidance, but robo advisors can do the same thing.
For example, many robo advisors rebalance your portfolio regularly depending on market conditions and asset allocations.
They also offer tax-loss harvesting services, which can reduce capital gains taxes.
Transparency
Transparency is another of the benefits of robo advisors. For instance, you can log into your online accounts anytime to read your account statement or view your portfolio (assuming that you’re an investor in more than one mutual fund or ETF).
Robo advisors also provide insight into how they construct portfolios using ETFs or mutual funds that you purchase and how they base their rebalancing strategies.
Cons of Using a Robo Advisor
Despite their pros, robo advisors also have some disadvantages. They include:
Lack of Human Interaction
In particular, you typically won’t find face-to-face contact or phone support from robo advisors.
However, for some do-it-yourself investors, the idea of human assistance may be unnecessary since these automated investment services can provide transparency and guidance through your online account portal.
Not a One-Size-Fit Solution
As noted, robo advisors aren’t a one-size fit solution for every investor. They’re geared more toward those who want to do it themselves and self-direct their investments.
If you prefer to have someone else manage your investments for you, robo advisors may not be the right choice.
Not As Helpful As Financial Advisors
For those that can afford it, hiring a human financial advisor is still typically the best choice. That’s partly because they’re more versatile and can provide customized advice better than robo advisors, which are limited by their algorithms and rebalancing strategies.
Note: At the end of the day, robo advisors are convenient and can help you achieve financial goals faster because they automate some aspects of investing. That said, it’s essential to be aware of their downsides, including the lack of human interaction and the possibility of making losses, just as you would with human advisors.
How To Choose the Best Robo Advisor for You?
Some things to consider when choosing a robo advisor are:
- Your Goals. If you have specific financial goals, such as saving for retirement or college, you will want to choose an advisor with specialized tools for this.
- Your Budget. Additionally, you should assess and determine your investment budget and check to see what fees you’ll be expected to pay. Some robo advisors offer free portfolios for certain minimum investments, while others charge a management fee based on the size of your account.
- How You’ll Access Your Account. It would be best to evaluate how easy it is to get information about your portfolio and make changes. For example, how often do you need to check your account, and what information can you get online?
- Your Risk Tolerance. Robo advisors use algorithms that generally include lower-risk investment strategies. If you’re more aggressive, then you may want to consider choosing a human financial advisor.
That said, here are three of the best robo advisers to consider:
- Fidelity Go: Fidelity Go is an online portfolio management service made by Fidelity Investments. Through the Fidelity website or mobile app, you can get personalized advice on saving and investing your money using a tailored set of ETFs.
- Betterment: This robo advisor automates your investment management process by creating a diversified portfolio of low-cost ETFs to help meet your specific personal goals. You can open a Betterment account for free. Its management fee is 0.25% of your account balance.
- Wealthsimple: Wealthsimple offers a sophisticated level of investing through its proprietary robo advisor technology. Wealthsimple manages your investments in one place, and you can get advice on all aspects of wealth management, such as saving for college, retirement, and taxes.
For more information on this topic, you’d be interested to read The Rise of the Robo Advisors by Demo Clarke (available on Amazon.com). The author explains how robo advisors work in detail and how to use them in investment decisions.
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Conclusion
Despite their disadvantages, robo advisors can be a beneficial option for many investors. Robo advisor portfolios are generally more diversified and automated than do-it-self accounts while still offering some degree of customization.
Therefore, if you’re interested in getting started with investing but don’t have a lot of time or money to manage your account, then a robo advisor might be worth considering. However, that doesn’t mean robo advisors guarantee results; you can still lose money, just like when using human services.
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