This post was created because one of my Facebook followers (who was also my left guard in high school football) asked a question: what is there to know about robo-advisors? This is an excellent question – thank you, Cody! There are really three types of advisors: financial advisors, robo-advisors, and you yourself as your own advisor. In this post, I will review each type of advisor and really get to the underlying point that you should consider – What is the cost to invest?
According to Investopedia, “A robo-advisor (robo-adviser) is an online wealth management service that provides automated, algorithm-based portfolio management advice without the use of human financial planners.” Essentially, these computer algorithms make investment decisions based on trends in the market. The fees for these types of services are significantly lower cost when compared to personal financial planners. Most robo-advisors cost less than 1% of the assets under management. Additionally, these robo-advisors are straightforward with any additional costs that you may incur (e.g. a yearly management fee). Many financial planners hide their fees – at least from the experiences that I’ve had. For example, here is the fee structure from Betterment, one of the new, popular robo-advisors.
It is important to note that these fees are tied directly to the amount that you are investing; therefore, the only service you get advice on is investing (not tax planning, estate planning, etc.). Investopedia has an article that includes all of the robo-advisors that are available today if you want to do some investigation. My take on robo-advisors is that they are great vehicles to use to start investing. If you have a company 401(k), but you are looking to open an IRA, Roth IRA, or you want to dabble in stocks – robo-advisors will provide that avenue to open an account and enable you to begin investing with very little fees. In contrast, you could look to a financial advisor, which I will discuss next.
There are many types of financial advisors out there and they carry many different titles and certifications. My recommendation, if you want to work with a person and not a robo-advisor, is that you work with a fee-only financial planner that is a fiduciary (someone that is legally bound to do what is in your best interest).
Why do I recommend fee-only financial planners? I have worked with a few financial planners that are not fiduciaries and after working with them for awhile I could tell that they cared more about what they were selling me. They did not focus on the goals my wife and I discussed with them, nor did they recommend plans or ideas on how we could achieve our goals. Instead, the focus of our conversations was about high-cost whole life insurance policies and individual retirement accounts (IRAs) that invested in A, B, and C funds (high cost!). I do think that life insurance is important depending on your situation, but if that is a majority of the conversation that you are having with your financial advisor – be leery on what their true motives are.
Always ask your advisor how they are being compensated for working with you. The big companies like Northwestern Mutual or Merrill Lynch are well-known because they have significant amounts of money to invest in marketing. Where do you think all of this money comes from? Fat commissions that the advisors make preying off of folks like you and me!!! The fiduciary financial planners I’ve seen are extremely transparent with the fees that they charge. I was introduced to fee-only financial planners from listening to Scott Alan Turner’s podcast. The XY planning website helped me find a financial planner that is a fiduciary in the area that I live. It has only been a few months that I have worked with this new financial planner, but I already enjoy working with him because he listens to what our goals are, and he is developing a plan to help us achieve our goals.
You as your own advisor
On my resources page, I list a few books that I’ve read to help me better understand personal finance. There are two books I would recommend to anyone that wants to start investing. First, I recently read the book The Smartest Investment Book You’ll Ever Read: The Proven Way to Beat the “Pros” and Take Control of Your Financial Future, which supports some of my arguments about the cost of some financial advisors. The thesis of this book, after the author drills in the fact that financial advisors that try to beat the market never actually beat the market, is four simple steps to start investing.
- Determine your asset allocation
- Open an account within certain fund families, which are explained further in the book. Vanguard and Fidelity are two that are highly recommended.
- Select your investments (recommendations are provided)
- Rebalance your portfolio
I was introduced to The Smartest Investment Book You’ll Ever Read after reading the 99 Minute Millionaire: The Simplest and Easiest Book Ever on Getting Started Investing and Becoming Rock Star Rich by Scott Alan Turner, which I reviewed in a previous post. Turner has a similar set of instructions to start investing.
I only have experience working with Betterment, which really is like investing by yourself with the help of a robo-advisor. The fees for Betterment include support for any questions that you have. Vanguard and Fidelity allow you to open your own accounts and select the types of investments you want to make. Vanguard has an online robo-advisor, but they also have a support line if you open an account with them – both Vanguard and Fidelity require higher initial investments compared to companies like Betterment.
In summary, the first thing that you should look at when you are ready to begin investing is the cost. Whether you are opening an account on your own or you are working with a financial planner – you should understand all of the associated fees. A few things to consider are fees related to 1) opening an account, 2) costs for making deposits or trading stocks, and 3) any yearly fixed costs (e.g. account maintenance fees). For young millennials, a robo-advisor is likely a good choice if you are looking for investment services. If you are looking for additional services, such as tax planning or estate planning, you should look into fee-only financial advisors/planners that are fiduciaries. Cheers!