Robo-adviser

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The term Robo-adviser generally refers to an automated digital investment advisory program. In most cases, the robo-adviser collects information regarding your financial goals, investment horizon, income and other assets, and risk tolerance by asking you to complete an online questionnaire. Based on that information, it creates and manages an investment portfolio for you. Robo-advisers often seek to offer investment advice for lower costs and fees than traditional advisory programs, and in some cases require lower account minimums than traditional investment advisers. The services provided, approaches to investing, and features of robo-advisers vary widely.[1]

Personal interaction

The amount of human interaction available to you may vary from one robo-adviser to another. Some robo-advisers may offer the opportunity to contact an investment professional to discuss your investment needs (this hybrid of both automated and personal advice is sometimes referred to as “bionic” advice). Other robo-advisers may only make technical support staff available, which will limit you to relying on the information on their websites or other sources you find to address your questions about investing.[1]

As with any adviser, it is very important you take the time to learn about the robo-adviser’s services, including the level of interaction with a person, and find out answers to any questions you may have. Here are a few questions to consider:[1]

  • Human interaction: How much human interaction is important to you?
    • Would you like to be able to ask a person questions about your investments, the investment strategy being used, and potential risks?
    • Would you like to be able to speak with a person during market events, such as periods of exceptional volatility or downturns?
    • Do you prefer being able to talk in person or on a phone, or is electronic communication fine with you?
  • Financial literacy: What is your level of financial literacy, especially when it comes to investing? Your ability to ask a person questions about investing (for example, about the robo-adviser’s investment strategy) may be limited and you may need to rely almost entirely on the robo-adviser’s online disclosures or other sources of information that you find on your own.
    • Are you comfortable using online resources?
  • Follow-up: As with a traditional adviser, you may be interested in how often you will have contact with the robo-adviser. For example, how often does the robo-adviser follow-up with clients to confirm any changes that would affect their investment choices?
    • Would you have to contact the robo-adviser with any updates to your financial situation?

Creating a recommendation

A robo-adviser uses information you provide to create a recommendation. As a result, a robo-adviser’s recommendation is limited by the information it requests and receives from you, typically through an online questionnaire. It is important to keep in mind that some robo-advisers may obtain and consider only limited information about you. In addition, as with traditional advisers, in many cases the burden to update this information will fall on you. Here are a few questions to consider:[1]

  • Financial goals: Would you use the robo-adviser for a specific financial goal (for example, retirement, buying a home, or investing for your children’s education), or to meet your overall financial needs more broadly?
    • Does the robo-adviser’s recommendation take into account your purpose in using the robo-adviser?
  • Financial situation: Does the robo-adviser’s recommendation take into account relevant personal financial information, given your goal?
    • For example, does the robo-adviser ask for information about high interest credit card debt or student loans you may have?
    • Does it take into account your bank and savings accounts?
    • Does it take into account your real estate holdings, such as your home, or other investments such as retirement accounts?
    • Does it take into account other assets that you have?
  • Risk tolerance: How does the robo-adviser take into account your tolerance for risk? How you respond to the robo-adviser’s questions about risk can affect what portfolio the robo-adviser recommends.
    • In addition to the initial makeup of your portfolio, how does your risk tolerance impact how the robo-adviser might rebalance your portfolio (for example, in the event of a market decline)?

Investing approach

Different robo-advisers have different approaches to investing, including different investment styles and different products offered. Some have several pre-determined portfolios of investments that they will recommend for you that you may or may not be able to customize. Some robo-advisers focus solely on a limited range of investment products, such as broad-based exchange-traded funds, or ETFs.[1]

You should take the time to understand how the robo-adviser develops a portfolio recommendation, and what pieces of information it uses – or does not use – in developing the portfolio. Here are a few questions to consider:[1]

  • Investment products: Does the robo-adviser offer a limited range of investment products, such as only ETFs?
    • Are the investment products utilized by the robo-adviser appropriate for your goals?
  • Portfolio limitations: Does the robo-adviser only offer certain limited portfolios within those investment products?
    • How many different portfolios could your money possibly be invested in?
    • What portfolio does the robo-adviser recommend for you and why?
  • Account types: What type of accounts does the robo-adviser manage? For example, does the robo-adviser manage individual retirement accounts (IRAs)? Taxable accounts? 401(k) accounts or college savings plans?
  • Tax loss harvesting: Does the robo-adviser utilize tax loss harvesting? Tax loss harvesting involves selling investments that have experienced losses in your account, which may result in tax implications. The value of tax loss harvesting can depend on your particular tax situation in a given year. It also may implicate rules against wash sales. Make sure you understand the tax implications of any sales, and consider whether you may wish to consult a tax adviser.[1]

Fees and other costs

Fees and other costs can greatly impact your return on investment. One of the main benefits of a robo-adviser can be lower fees and costs – so it is very important that you understand what you would be charged. A robo-adviser may offer lower-cost investment advice, but if the robo-adviser utilizes investment products with high costs, your total overall costs could still be high. It’s important to understand your total costs.[1]

Fees are disclosed as part of an adviser's SEC filing, see below.

Licensing and registration

Firms that provide advisory services in the U.S. are typically registered as investment advisers with either the SEC (Securities and Exchange Commission) or one or more state securities authorities. Although the services that they provide are automated, robo-advisers in the U.S. must comply with the securities laws applicable to SEC or state-registered investment advisers. Use the SEC’s IAPD Investment Adviser Public Disclosure (IAPD) database, which is available on Investor.gov, to research the background, including registration or license status and disciplinary history, of any individual or firm recommending an investment.[1]

Like traditional investment advisers, robo-advisers are also required to file a Form ADV.[note 1] Robo-advisers may also offer certain information about their advisory business on their websites or in communications with clients. Check the robo-adviser’s website regularly to see if there is any updated information.[1]

Table 1. Representative SEC Filing Information
Robo-adviser Website info FINRA BrokerCheck®* SEC Fees**
Betterment Form ADV Part 2
Includes Part 2A
BETTERMENT SECURITIES,MTG, LLC,PARK HILL CAPITAL, INC. BETTERMENT LLC (CRD# 149117 / SEC# 801-70171) Form ADV Part 2A
Wealthfront Legal Documents
Includes SEC Form ADV 1 and ADV 2
WEALTHFRONT BROKERAGE CORPORATION WEALTHFRONT INC. (CRD# 148456 / SEC# 801-69766) Form ADV Part 2A
* FINRA - Financial Industry Regulatory Authority, Inc.

** Under "Brochures", download the PDF file. Fees are disclosed in this document.

Risks and limitations

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.[2]

  • Understand any terms and conditions. Review all relevant disclosures for an automated investment tool.
    • Understand any terms and conditions, such as the fees and expenses associated with using the tool or with selling or purchasing investments.
    • Find out how you can terminate any agreement or relationship, and how long it may take to cash out any investments if you decide to stop using the tool. If anything is unclear or you need additional information, directly contact the automated tool sponsor.
    • Ask an automated investment tool sponsor whether it receives any form of compensation for offering, recommending, or selling certain services or investments.
  • Consider the tool’s limitations, including any key assumptions. Be aware that an automated tool may rely on assumptions that could be incorrect or do not apply to your individual situation. For example, an automated investment tool may be programmed to use economic assumptions that will not react to shifts in the market. If the automated tool assumes that interest rates will remain low but, instead, interest rates rise, the tool’s output will be flawed.
    • In addition, an automated investment tool, like other investment programs, may be programmed to consider limited options. For example, an automated investment tool may only consider investments offered by an affiliated firm.
  • The tool’s output directly depends on what information it seeks from you and what information you provide. Which questions the tool asks and how they are framed may limit or influence the information you provide, which in turn directly impacts the output that an automated investment tool generates.
    • If any of the questions are unclear or you do not understand why the information is being sought, ask the tool sponsor.
    • Be aware that a tool may ask questions that are over-generalized, ambiguous, misleading, or designed to fit you into the tool’s predetermined options.
    • In addition, be very careful when inputting your answers or information. If you make a mistake, the resulting output may not be right for you.
  • The tool’s output may not be right for your financial needs or goals. An automated investment tool may not assess all of your particular circumstances, such as your age, financial situation and needs, investment experience, other holdings, tax situation, willingness to risk losing your investment money for potentially higher investment returns, time horizon for investing, need for cash, and investment goals. Consequently, some tools may suggest investments (including asset allocation models) that may not be right for you.
    • For example, an automated investment tool may estimate a time horizon for your investments based only on your age, but not take into account that you need some of your investment money back in a few years to buy a new home. In addition, automated tools typically do not take into account that your financial goals may change.
    • If the automated investment tool does not allow you to interact with an actual person, consider that you may lose the value that human judgment and oversight, or more personalized service, may add to the process.
  • Safeguard your personal information. Be aware that an automated tool sponsor may be collecting your personal information for purposes unrelated to the tool. Understand when and with whom your personal information may be shared. If you have questions that are not answered in the tool’s privacy policy, contact the tool’s sponsor for more information.

Robo-adviser reviews

The robo-adviser field is changing at a rapid pace; in both the number of companies and competitive features offered. Here is a a short list of robo-adviser review sites.[3]

Each review site will cover a different perspective. Be sure to keep your own situation in mind when selecting a robo-adviser. Also, the SEC filing information and website customer agreements are the most accurate sources of information.

If you have any questions, please ask for assistance in the Bogleheads forum.

Member reviews

Portfolio performance

A portfolio's performance (return over time) depends on your asset allocation, which is a which is a balance of your ability, willingness, and need to take risk. The selection process is no different with a robo-adviser portfolio than one based on a "conventional" portfolio from, for example, Fidelity, Schwab, or Vanguard.

Robo-adviser portfolios typically hold more funds than a lazy portfolio, but that does not guarantee a better return. A comprehensive discussion can be found in this Bogleheads® forum topic: Backtesting some robo-advisers asset allocations.[note 3]

Notes

  1. Investment advisers file Form ADV to register with the SEC and/or the states. Some advisers that are exempt from registration (Exempt Reporting Advisers) also complete a portion of the questions in Form ADV for purposes of reporting to the SEC and/or the states. All investment advisers must periodically update the information in their filings. Form ADV contains information about an investment adviser and its business operations. Form ADV also contains disclosure about certain disciplinary events involving the adviser and its key personnel. Source: Investment Adviser Public Disclosure, from the SEC.
  2. 2.0 2.1 2.2 2.3 2.4 2.5 jbolden1517 does not personally use this robo-adviser.
  3. Investors who are uncomfortable using a robo-adviser, but still wish to manage their own investments, should consider a target date fund instead. These "Set and forget" type funds have been performing "automated" investment management for quite some time - well before the advent of robo-advisers. See: Bogleheads® forum post: Backtesting some robo-advisers asset allocations, by forum member LadyGeek

References

  1. 1.0 1.1 1.2 1.3 1.4 1.5 1.6 1.7 1.8 1.9 Investor Bulletin: Robo-Advisers, SEC.gov, viewed July 17, 2017
  2. Investor Alert: Automated Investment Tools, SEC.gov, May 8, 2015
  3. Bogleheads® forum post: Re: What we know about robo advisors, by forum member jbolden1517.

Further reading

  • Fein, Melanie L., Robo-Advisors: A Closer Look (June 30, 2015), SSRN. Abstract: ...robo-advisors do not live up to the DOL’s acclaim. They are not designed for retirement accounts subject to ERISA and should be approached with caution by retail and retirement investors looking for personal investment advice.

External links

SEC