Reasons Why You Might Want to Avoid a Robo-Advisor: Are You Using One?

Betterment. Wealthfront. Dozens of robo-advisors litter the financial landscape.

Robo-advisors have been touted as the best option for those just starting out investing. They're heralded as some of the lowest-cost options that can hone in on your exact needs and risk tolerance with the accuracy of an Olympic archer. 

However, they're not without their limitations. Here's what you need to know if you're thinking about using a robo-advisor or have already started using one. It might not clinch your future like you think it will.

What is a Robo-Advisor?

Robo-advisors use algorithm-driven digital trading and investing platform. They build financial portfolios based on your goals and risk tolerance with little to no human guidance. Robo-advisors, as you might imagine, offer some automatic features, such as rebalancing and tax optimization. 

Here's a quick overview of how a robo-advisor works: You'll take a quick survey so the robo-advisor "understands" your goals and learns how to automatically invest your money. Sometimes human advisors can answer your questions, but that isn't always an available feature or option.

Based on the answers you provide, the robo-advisor's algorithm puts together a portfolio of investments that hit your exact time horizon and goals. You can arrange for a robo-advisor to automatically add contributions from your bank. Finally, the robo-advisor manages your portfolio, using technology to implement tax-loss harvesting so you can offset capital gains and also rebalance your portfolio.

Reasons Why You Might Steer Clear of a Robo-Advisor

Even if all of this sounds easy-peasy, here's why you might want to look into alternative options instead.

Reason 1: They may offer a limited range of financial assets.

Robo-advisors often offer a lack of diversification compared to other options. Robo-advisors might not offer you the broadest sweep of asset classes, from cash to real estate to commodities. 

Reason 2: They have a limited view of your financial situation. 

Well, of course they do. They're robots. 

The point is, most people have very, very nuanced individual needs. Furthermore, robo-advisors lack the subjective thoughts that a human financial advisor can bring to the table. 

For example, let's say your investing plan has been going smoothly for years. Then a wildfire brews up and wreaks havoc on your property. Will a robo-advisor be able to tell you what to do then? 

No. 

What happens when your normally healthy child suddenly develops cancer? Your financial situation could change overnight and require a drastically different investment approach. A robo-advisor cannot offer detailed planning advice. 

Reason 3: Active investors won't find them stimulating.

If you're not a passive investor, you'll find robo-advisors boring. If you're a day trader, a robo-advisor won't cut it for you, unless you choose to diversify your nest egg with long-term investments as well (a good idea). Even in that situation, though, you probably want to invest with a brokerage account that also allows you to actively trade and try out various trading strategies.

Reason 4: Your robo-advisor only does what it's told.

A robo-advisor can't reason with you. (Unless, of course, it offers a human advisor component.)

For example, let's say you're 24 and you tell a robo-advisor, "I'm not comfortable with risk" without understanding the implications. A robo-advisor doesn't care that your money won't grow. It'll sling your money into low-yield bonds and call it a day. It won't give a rip if your money grows at a snail's pace over the course of 20 years.

A human advisor may help you realize that you need to change your strategy. For example, a human advisor can say emphatically, "You'll only earn $22,000 on a $10,000 investment with this 2% bond return you've selected. However, let's say you increase your risk tolerance and get 8% returns instead. You'll earn over $215,000 on this $10,000 instead." 

A human advisor can visually demonstrate what your choices mean over time. 

Reason 5: Robo fees don't always project transparency.

Sure, robo-advisors cut out the middlemen and many of the fees, but they still profit from their customers. 

Some robo advisors make money by sticking your money into funds in which they'll earn more — even if the investment doesn't really make sense for your needs. 

Don't Like Human Advisor Fees? We Get It. However...

Think you'd rather DIY it than hire a financial advisor because you'd like to avoid the fees? We understand.

However, think about this: Sometimes not getting a financial advisor can cost you hundreds of thousands of dollars over your lifetime. If you don't have time to manage your passive assets, you may want to consider getting a human financial advisor to help. When you get busy with your job, kids, walking the dog, etc., handling your money and investments can go right into the slush pile.

Also, keep this in mind: Human advisors also recommend passive investment strategies. Many people assume that they only promote active management, but they also encourage passively managed investments like ETFs. And truth be told, if the right actively managed fund comes up that matches your short-term and even possibly your long-term financial goals (or possibly incorporates your ESG preferences), why not take a look? 

Human advisors can also offer tax strategies that go beyond basics like tax harvesting. In larger portfolios especially, tax efficiency can more than pay for the added fees that accompany traditional advisory accounts.

Make Good Moves — You Get a Limited Number of Shots

You don't want to make a mistake. You've only got one financial future. Kind of like choosing a career, you only have one lifetime to make the choices you want to make. You can always change your career trajectory, but getting started late or making a dozen different choices along the way can result in money setbacks.

Make the right decisions for yourself based on your needs. If you need help from a human advisor, that's okay. It may even massively benefit you financially down the road. Fees can sometimes be a good tradeoff in the long run for great returns.