The Pros and Cons of Using a Robo-Advisor for Investing

[00:00:00] Eric Brotman: This is Eric Brotman, the host of Don’t Retire… Graduate!: the podcast that teaches you how to advance into retirement rather than retreating. Welcome to office hours where we answer listeners’ questions about personal finance, retirement readiness, and more. We received a question from Yazan who asked: what are the pros and cons of using a robo-advisor for investing? And it’s a great question because there are so many tools and resources and and apps and other things that will allow people to invest in ways that don’t necessarily require either human interaction or, or payments to advisors and so forth. So let’s talk about the pros and cons and you asked about it in terms of investing, but I would like to broaden that if it’s okay and talk, not just about investing, but also about financial planning in general.

 On the investing side, I would say robo-advisors have a very defined place. A robo advisor can do a fabulous job in building a portfolio that’s appropriate. It can look at your, it can look at your risk tolerance, at least as you define it. And it can certainly build a diversified portfolio for you in a way that is very efficient and very inexpensive.

There’s a couple of cons. One is that because most of these are gamified, it does potentially encourage some strange behavior by users because it encourages transactions because you get badges and so forth for some of the transactions. So that makes me a little uncomfortable. Beyond that, it also only assumes that the end user, you as the user, are rational. And unfortunately, while computers are rational all the time, think Mr. Spock, humans are not. We’re very emotional creatures. And behavioral finance is a, is a growing field because a lot of the decisions that we make about money are not made in a rational, thoughtful way.

They’re not made when seas are calm. They’re made when seas are choppy and things are going wrong. So for example, a robo-advisor might be able to help you rebalance a portfolio after a 10% up year or a 10% down year. No problem. What it can’t do is help you figure out what am I going to do now I had a job loss or I had triplets, or I had a parent die or a spouse?

It can’t help you with with things that are related to, you know, I’m going through a divorce. What do I do with my house? And how do we, how do we handle these assets? Or I’ve got this job offer, how do I compare these various employee benefits or these plans or all these other kinds of things. So, I think financial planning is not really robo advisor territory despite the fact that portfolio construction can be. I consider portfolio construction to be a very small ancillary piece of the financial advising process. And while you’re able to do it with computer algorithms, you have to be able to stick to your guns when things aren’t great. And if the, if the robo-advisor says, Yazan, you got to put away a thousand dollars a month and you’ve got to do it for 20 years, and you’ve got to average some, some rate of return and then the rate of return changes and it says now, instead of a thousand dollars a month, you need to do 1500. The question is, how do you decide A: am I going to do that? Am I able to do that? And B: where does that come from? How do I handle that in terms of my cashflow? Or how do I handle that in terms of some of the other decisions that I’m making?

Does, am I robbing Peter to pay Paul? So the short answer is there are definitely pros of using robo-advisors for investing. One of them is cost. One of them is convenience and efficiency. I think the cons tend to match those pros. I think it’s a bit of a wash from an investing standpoint, but from a financial planning standpoint, I can consider it very con heavy. I think trying to use a computer or a computer program or anything that’s fully remote and fully automated to help you with complicated life decisions to me is, is not a very helpful thing. To me, it’s a fool’s errand. So if you’re looking to have a robo-advisor help you allocate your 401k and you’re putting away X dollars a check and so forth, that’s great. Go for it. But when you start getting into estate planning and risk management and cashflow and budgeting and marital questions and things about kids’ education and aging parents and all the things that financial planning, even just the quantitative piece of, of financial planning has to look at, I would caution you against using a robo- advisor for that.

So I hope I’ve answered your question effectively. Short answer is go for it if it’s just for a simple investment allocation, but avoid it if it’s for true life planning, life financial planning advice. So, Yazan, thanks for your question. If you’d like to send us a question which we might answer in a future episode of office hours, post it on our Facebook page or tweet us at @Brotmanplanning.

If you like what you hear, please subscribe to our podcast and leave a rating on Spotify or wherever you listen to your favorite shows. Please also check out our books, workbooks and online financial literacy resources at brotmanmedia.com. Thanks for coming to office hours. Be sure to tune in every Thursday for new content. For now, this is your host, Eric Brotman, and reminding you: don’t retire. Graduate!