What Are Robo-Advisors? And Why Are So Many Financial Advisors Against Them?

I was having lunch with a buddy I hadn’t seen in years. After catching up on ‘whatever happened to old what’s his name?’ the conversation naturally turned to the stock market, investing in general and retirement planning.

Hey, if you take a CFP to lunch—and you’re buying—why not get a little free advice?

He was thinking about changing financial advisors. Things were OK—he felt like the firm he was currently with did a good enough job, but they were raising their annual fees and frankly he wondered if he was still getting a good deal.

The firm he’s currently with is known for it’s home cooking: selling their own brand of under-performing mutual funds. In fact, about five years ago some employees sued the firm for stuffing it’s own 401(k) with mutual funds run by the company’s investment arm.  That’s when you know a financial advisory firm has a problem: when its advisors sue it for doing a lousy job of running its own retirement plan.

robo advisorI told my friend, “You should consider a robo-advisor.”

He looked at me as if I had just told him to get financial advice from a Star Wars character.

“What’s a robo-advisor?”

He almost looked like he was in pain.

So I told him. Robo-advisors are computer programs that put together an investment mix and monitor and adjust it automatically.

It’s doing what a financial advisor says he will do—but rarely actually does.

Here’s the thing. You hire a financial advisor and you think, “OK, he’ll keep an eye on things and make sure I stay on track for retirement.” But most of the time, advisors will steer you to some “model allocation program” made up of mutual funds or exchange-traded funds and charge you something along the line of a 1% management fee. And that’s in addition to the expenses built in to the funds or ETFs.

These programs are called “managed accounts” by the big investment and brokerage firms.

And that’s exactly what a robo-advisor is. A managed allocation program—without the 1% additional fee. Most of the leading robo-advisors—like Vanguard’s Personal Advisor Services or Betterment—charge 0.30% or less. And their mutual funds and ETFs have lower internal expenses than the average (or worse) mutual funds a lot of financial advisors recommend.

Vanguard claims the management fee difference alone can add over $90,000 of value to a portfolio over 20 years. Human financial advisors worry that robo-advisors will cut into their profits. And they should.

So my buddy took all this in and frankly seemed totally unimpressed. In fact, he sent me a text later asking about some investment plan that he had found online. A do-it-yourself allocation of mutual funds that he was apparently considering.

Maybe he’ll try to manage his own investments, or even stay with his current advisory firm. It doesn’t seem likely that he’ll go with the low-cost, machine-made investment option.

Perhaps I didn’t do a very good job of explaining robo-advisors to him.

So maybe he’ll offer to buy me lunch again.

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