Robo-advisors are revolutionizing financial services and making investing more accessible given their lower costs and low minimums to get started. Some robo-advisors, like Personal Capital, even offer free financial tools for you to use to keep track of your net worth and analyze your own investments if you wish.
Millennials are jumping on board given they are tech savvy. They also realize that high fees are the way of the past, especially since many traditional advisors underperform and don’t provide worthwhile services. The internet has made things very transparent, which means inefficiencies and high costs should go the way of the dinosaur.
Since robo-advisors have only been around since Wealthfront invented the category in 2008, many people still wonder whether they can be trusted to invest their hard-earned money. The key thing to realize is that all robo-advisors are regulated by FINRA, the financial regulatory authority responsible for regulating all financial institutions. Robo-advisory oversight is just as tight, if not tighter than banking oversight since they are a newer breed.
Security Is Tantamount
In the past few years, security breaches have endangered consumers’ personal and financial information. As we live more and more of our lives online, we also increase the risk of our information getting into the wrong hands. Putting all your trust — and money — can be potentially risky.
Luckily, some robo-advisors are putting measures into place to increase security. Personal Capital has a two-step verification, where a code will be sent to your mobile phone in order to access your account. In addition, they will lock down your account if there is any suspicious activity. The founders of Personal Capital were founders of a security firm called PassMark Security before founding Personal Capital, therefore, they are experts in the space.
Further, each robo-advisor has a custodian bank who actually holds your money. Personal Capital’s custodian bank is Pershing Advisors, part of Bank of Mellon New York, which has over 1 trillion in assets. They aren’t going anywhere.
One of the biggest concerns with robo-advisors is their actual performance. If you’re going to throw the majority or all of your cash at a robo-advisor, you want to ensure you get a return on your investment and that your money is working for you.
“While automated investment tools may offer clear benefits — including low cost, ease of use and broad access — it is important to understand their risks and limitations before using them. Investors should be wary of tools that promise better portfolio performance,” according to the Securities & Exchange commission.
Below shows the performance of various robo-advisors based on the same profile filled out on each platform. The goal was to get a 60% equity / 40% fixed income asset allocation. Not bad given the S&P 500 was up 10% for 2016, and fixed income was only up 3%. The math would dictate a 60/40 portfolio split would return 7.2% instead.
No Human Hand Holding For Pure Robos
Though robo-advisors do their best at personalizing their advice to your particular situation and your financial goals, at the end of the day, they are using an algorithm to make big financial decisions. The good thing is, so are all the traditional financial advisors who charge 1-3%. Most all investment advice is based on Modern Portfolio Theory, which was pioneered in the 50s, and subsequently refined each year.
It’s also important to consider what kind of support you’ll want during a downturn in the market. So far, every single robo-advisor has survived through a bull market that started in 2009. What happens when the markets turn? Will you bail out with one whiff of a correction? Will the algorithms hold up and outperform? These are unknowns, but I suspect with the appropriate asset allocation, you will perform just as well as if a traditional advisor managed your money. After all, they are human, with emotions too.
The key is to continuously dollar cost average and hold on for the long term. Nobody has lost money in the stock market in any 10 year stretch. If you want to have human advice, Personal Capital is a hybrid robo-advisor with both human advisors and algorithms to help you grow your wealth.
There are plenty of life events that can be discussed with an advisory e.g. birth of child, home buying, insurance policies, retirement planning, estate planning, and so forth.
Check out the Securities and Exchange Commission’s Investment Advisor Search. You can input the name of the firm to see if they are registered. Any firm or brokerage who manages money is required to be registered with the SEC, and this includes robo-advisors. All robo-advisors I cover on Financial Samurai are registered.
You can also use BrokerCheck, by the Financial Industry Regulatory Authority (FINRA), to learn more about the firm, their disclosures and more.
In addition, you’ll want to pay attention and check the robo-advisors clearing house / custodian bank. Custodians add an extra level of security and regulation. All robo-advisors covered on Financial Samurai have custodians.
What Happens if They Go Under?
A robo-advisor’s corporate money is completely separate from your customer money at all times, and a robo-advisor is not allowed to use your money to pay for its operations or anything other than investing for you. You own all the underlying securities in your robo-advisor portfolio, and if you close your account your money will be transferred back to your linked checking account. If we were to close, the funds would be transferred to the broker of your choosing.
Further, there is SIPC (Securities Investor Protection Corporation) protection up to $500,000 per account type against losses resulting from the failure of a broker-dealer. Most people have less than that invested. Unlike FDIC insurance for banks, SIPC does not protect against losses due to normal swings in the market.
You should look out for two more things before investing with a robo-advisor:
- The amount of funding they have
- The amount of assets under management they have
Since most robo-advisors are private and independent, the more funding they have, the longer they will last. The robo-advisors with the largest funding are: Personal Capital, Wealthfront, and Betterment with $150 – $200M in funding each. They also have the largest assets under management with $3.5B – 5B each.
Just know that even at $5B in assets under management, if they earned a 0.25% fee each year, they are only making an operating profit before tax of $12.5M. It costs more than $12.5M a year to run each one of the top three robo-advisors. Hence, I estimate each one will have to get to about $10B in assets under management before they can be operating profit positive and no longer need debt or equity funding.
The internet and technology has made everything cheaper and more efficient for consumers. It’s worth taking advantage. At least utilize Personal Capital’s free financial tools to manage your wealth. I’ve been using their free tools since 2012 and have seen my net worth sky rocket. You don’t need to send them a single dollar since their app is free.
You can also sign up for Wealthfront for free and answer their short questionnaire to see what type of model portfolio they’d build and invest for you. The key to wealth is to save often and invest regularly. If you automatically contribute 20% or more of your paycheck in a risk-adjusted manner, you will likely be much wealthier than the person who spends frivolously or hoards cash. Inflation is too powerful of a force to combat. Instead, ride the inflation wave by buying real assets.
Like with everything new, start small and work your way up. That goes with large banks who’ve been around for decades. You want to make sure the service and performance is up to par before committing large amounts of capital. I’ve been researching and writing about robo-advisors since 2009 when I started Financial Samurai, and have witnessed their growth. I’ve met with most senior management of all the firms since I’m based in San Francisco, and there’s a real, unstoppable movement going on in the space.
About the Author: Sam began investing his own money ever since he opened an online brokerage account in 1995. Sam loved investing so much that he decided to make a career out of investing by spending the next 13 years after college working at two of the leading financial service firms in the world. During this time, Sam received his MBA from UC Berkeley with a focus on finance and real estate. He also became Series 7 and Series 63 registered. In 2012, Sam was able to retire at the age of 34 largely due to his investments that now generate roughly $200,000 a year in passive income. He spends time playing tennis, hanging out with family, consulting for leading fintech companies and writing online to help others achieve financial freedom.
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