Should you use a robo-advisor or a real-life financial planner to help you with your investments? Well, although we obviously have a conflict of interest here (after all, we are financial planners!), as fiduciaries, we believe that it's our job to turn away clients if they have a better option elsewhere. So when robo-advisors started making waves, I did some digging into the pros and cons of using a robo-advisor. I wanted to know: Does it make sense for certain people to use a robo-advisor instead?
Here's what I found.
Why not use an investment advisor?
Let's be clear here: many people simply do not need an investment advisor. While some financial planners insist their services are necessary for everyone with even a nickel in their IRA, we feel that there are many situations that don't warrant you paying an advisor a 1% fee (or more) for advice. Here are some reasons why NOT to use a full-blown financial planner:
- If you’re interested in finance enough to want to manage your own finances, and you have the time and energy to put forth, you can probably go the DIY route. Most of our clients could manage their own finances, after all - they just either are too busy or simply don't want to do it themselves. An advisor is really not necessary for someone who likes to learn about personal finance or who enjoys keeping up with their investments. Many advisors charge a fee for assets under management (AUM) and so if you want to manage your own money, the expense may not be worth it.
- If your finances are simple, an advisor is overkill. Most young people don’t need to pay someone to give them what amounts to very basic investment advice. Too many investment advisors will put you in complicated portfolios and do more trading than necessary to justify their fee. The best investing is as exciting as watching paint dry. When you're approaching retirement, or if you are highly compensated with equity, a tax-focused advisor may be worth your money. If all you're asking your advisor is how to invest your IRA, you probably don't need one.
- Many “investment advisors” are not true fiduciaries giving you advice in your best interest; rather, they are simply glorified salespeople who earn commissions off of high-cost investment products. There is no regulation around using the term "financial planner" or "financial advisor." For that reason, we would always recommend making sure you hire an actual CERTIFIED FINANCIAL PLANNER™ if you do decide to hire an advisor.
What are some other alternatives to hiring a financial planner?
- For beginning investors who just want a place to get started, I always recommend William Bernstein’s If You Can: How Millenials Can Get Rich Slowly.
- There is a lot of good information online, but it can be hard to know who to trust. I am a huge fan of the Bogleheads forums (for specific questions) and wiki (for general personal finance information): Many advisors are not fiduciaries (who must act in your best interest), but the people volunteering their time to give away information for free online have no conflict of interest – after all, you’re not paying them anything! Their reading list is also great for DIYers.
- Vanguard’s advisor option is probably the best out there for those who want to outsource their financial advice without going the full-service route (disclaimer: I don’t work for Vanguard, I’m just a fangirl). For a very low fee (0.3% AUM currently), you get access to a Vanguard CFP®. For someone who doesn’t feel comfortable managing their own investments, or who just wants someone to look over their options, Vanguard is a good choice.
- Hourly planners or fee-only planners. The Garrett Planning Network has fee-only advisors who work for an hourly rate. They are a good option for people who just have a single specific question (e.g. “When should I claim Social Security?”) and don’t require you to pay an ongoing advisor fee. If you do end up using a financial advisor, you want to make sure they are fee-only fiduciaries who are required to act in your best interest, and not just glorified salespeople. The National Association of Personal Financial Advisors - NAPFA.org - and the Garrett Planning Network are the two best options in this case.
Is a robo-advisor a better option?
Almost certainly not. When I heard about robo-advisors, I checked out a few of the top names (Wealthfront, Betterment) and found their services to be lacking in a few major ways. Here are the main problems that I had with robo-advisors:
- Most robo-advisors charge a fee higher than Vanguard’s advisory service and deliver little in the way of personalized advice. The main benefit touted by most robo-advisors is the higher after-tax returns created from tax-loss harvesting. But most investors don’t realize that tax-loss harvesting is actually just deferring taxes. An investor in a low tax bracket may actually end up paying more in taxes later on because of this tax deferment, or if tax laws change.
- Loss of control. With a robo-advisor, you have no control over how much tax loss harvesting is done in any given year. Using a roboadvisor means you lose control over your tax planning. As a financial control freak, this is the main reason that convinced me not to go with a robo-advisor.
- Many robo advisors have overly complicated portfolios that are costly to unwind if you change your mind and want to invest elsewhere. If you want to understand your own investments and keep your portfolio simple, it is cheaper and easier to do it yourself using a low-cost brokerage like Vanguard or Fidelity.
To sum up: if you want to DIY your finances and your situation is simple, we encourage you to dive right in! We absolutely love learning about finances, and we think everyone should have at least a basic understanding of their investments. If you want some outside help but don't have the money or inclination to pay a full blown financial planner, there are plenty of online resources that can help (and some cheaper alternatives if you just need assistance in a single area, say, investment advice).
Once your situation gets too complicated, or you get too busy to keep up with your finances, that's when a full-service financial planner can really help. We love helping people plan for the bridge years before and during retirement, for example, since the tax savings from a multi-year tax plan can easily surpass our flat fee.
But robo-advisors are the worst of both worlds: for a simple situation, you are overcomplicating your investments without much benefit (and possibly making your taxes worse down the road). For a complicated situation, a robo-advisor can't take into account really major factors - say, if you're planning to buy a house soon or need help with Roth conversion planning. Perhaps robo-advisors will get more sophisticated down the road as they build out their service offerings. But right now, in my opinion, they aren't worth the high fees for the limited service they provide.
Not sure if you need to hire a financial planner? Let us know what your situation is and we'll be happy to discuss your options (our promise: we'll never, ever pressure you to hire us):