Are robo-advisors becoming increasingly popular, and can they truly replace human financial advisors?

• Algorithms are used by robo-advisors to automate investing and create portfolios for users. In the near future, they may manage over $1 trillion of Americans' wealth.
• Digital culture and the iPhone's advent led to the emergence of services around 2008.
• In certain instances, robo-advisors might outperform human financial advisors, particularly for individuals who are new to investing, have limited wealth, or lead simple financial lives.

Robots want to be your next financial advisor.

Recently, the idea of a cyborg like C-3PO from "Star Wars" wearing a power suit on Wall Street might have seemed like science fiction fantasy.

Soon, robo-advisors may manage over $1 trillion of Americans' wealth.

Instead of physical robots, companies have created algorithms to automate digital investing. By inputting details such as age, savings goals, and risk comfort into a computer or phone app, the algorithm constructs and manages a customized investment portfolio for you.

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Is a robo-advisor more suitable for all investors than a human financial planner?

Robo-advisors are suitable for certain individuals but not for everyone, according to Ivory Johnson, a certified financial planner and founder of Delancey Wealth Management in Washington, D.C. He likens robo-advisors to different golf clubs, suggesting that they are simply an alternative option for playing the same game.

Depending on my location, I use my 7-iron or not.

‘They’re everywhere’

Since the iPhone's public debut in 2007, robo-advisors have been emerging for everyday investors.

Over a decade ago, robo-advisors were managing around $785 billion, according to Backend Benchmarking, which specializes in research on digital advisors.

Numerous companies have created their own models to take advantage of the growing popularity and digital culture.

There are various types of investment firms, including independent shops such as Betterment, Personal Capital, and Wealthfront, traditional Wall Street brokerages like Fidelity Investments, Merrill Lynch, and Morgan Stanley, and those that cater to 401(k) plan investors, like Financial Engines.

Players who have traditionally catered to an older and affluent audience can utilize technology to attract a younger demographic of investors who are passionate about the digital financial space, as evidenced by their use of online trading apps such as Robinhood and their interest in assets like cryptocurrency.

In the past decade, major banks and discount brokers have introduced robo-advisors, which are now ubiquitous, according to David Goldstone, research and analytics manager at Backend Benchmarking.

Who’s a good candidate?

According to industry experts, newer investors who haven't accumulated much wealth often find robots to be particularly suitable for managing their finances at a relatively low cost.

One advantage of robo-advisors is their low barrier to entry, resulting from minimal or no account requirements.

Acorns, Fidelity Go, Betterment, and Ellevest offer a robo service for women that allows clients to sign up for their baseline digital service without any prior wealth. In contrast, Merrill Edge Guided Investing, SigFig, SoFi, Vanguard Group, and Wealthfront have minimums ranging from a few dollars up to $3,000.

Goldstone stated that traditional firms typically manage clients' money with a minimum investment of $250,000.

It's not surprising that the typical Wealthfront client is younger, with about 90% of the 470,000 clients being under 40. Their average balance is approximately $60,000.

The trend among that demographic is influenced by a stronger digital preference among millennials and Generation Z, who, being digital natives, may be more drawn to a robo service.

Stolnitz stated that our users desire to manage their finances in a similar manner to how they manage other aspects of their lives, such as online food delivery through DoorDash.

According to Dan Egan, the firm's vice president of behavioral finance and investing, Betterment has an average user younger than 40, with a $55,000 to $60,000 account.

The company has clients of all ages, including those in their 60s and 70s with multimillion-dollar portfolios, and the oldest user is over 90.

Egan stated that he believes it draws individuals seeking to delegate portfolio management.

Goldstone stated that robo-advisors typically charge between 0.25% and 0.35% annually for their advice service, which is about a quarter of the cost of a traditional financial advisor who charges 1% a year on client assets.

An investor with $100,000 would pay a typical human advisor $1,000 a year and an average robo $250 for their services, although some human advisors charge different fee structures such as monthly subscription fees or one-time consultation fees.

Some robo-advisors, such as Charles Schwab and SoFi, do not charge any advice fees, while others, including Fidelity and SigFig, only charge fees on balances over $10,000.

Some firms invest clients in their own branded funds, which increases their revenue through fund fees. Additionally, they may charge higher account minimums or fees for different levels of service.

William Whitt, a strategic advisor at Aite-Novarica Group, stated that if you are in your 20s and 30s and don't have a lot of money, your portfolios are likely to be quite good.

Trade-offs

Using a purely digital service may come with trade-offs.

Although digital services can automate crucial investment tasks such as fund selection, stock-bond-cash allocation, and portfolio rebalancing, human advisors complain that algorithmic programs lack the ability to communicate with clients in real-time.

Rewritten sentence: Providing guidance and support during challenging times, such as job loss or a declining stock market, can help individuals navigate through difficult situations and find solutions.

Financial planners believe they are better suited for proactivity and addressing clients' needs beyond money management, such as tax, estate, or business planning, which may be too complex or nuanced for an online questionnaire.

Johnson at Delancey Wealth Management stated, "We invest in more than just the stock market."

Johnson stated that assisting a client in making decisions about exercising stock options, purchasing long-term-care or liability insurance, or establishing a business as an LLC or another type of entity are likely beyond the capabilities of a digital advisor.

It’s also a challenge to automate client psychology.

Whitt stated that online questionnaires used by robo-advisors to determine the best portfolio for a client do not have the ability to analyze answers and body language in the same way that a human advisor can.

Some experts believe that determining what makes a client happy, which is essentially the purpose behind their money, may be beyond the capabilities of robots.

"To comprehend fully, financial advisors may inquire additional questions," Whitt stated.

The Securities and Exchange Commission recently reviewed robo-advice services and questioned whether they consistently recommended portfolios that aligned with clients' stated risk tolerance. The agency did not specify which firms it examined.

Not all human advisors may be performing their functions appropriately, and some may only manage client investments without assessing goals or other complex financial-planning details. In such cases, clients may benefit more from a robo-advice relationship.

According to Brian Walsh, SoFi's senior manager of financial planning, humans offer value, but robos excel in cost-efficiency on the investment side.

Evolution

Platforms for robots have evolved to address criticisms and attract a wider range of investors.

Many financial advisors now provide more complex levels of "goals-based" planning, offering investment and saving recommendations based on short- and long-term goals such as buying a home, going on vacation, saving for college, or preparing for retirement.

Some financial services now provide a hybrid option that allows for either a one-time consultation with a financial planner or a long-term relationship with a human advisor.

For instance, Charles Schwab's premium service includes a $300 initial consultation fee and a $30 monthly subscription fee for human advice in addition to its digital investment management.

At Wealthfront, users can call a hotline to speak with accountants, CFPs, and financial analysts if they have any questions, as stated by Stolnitz.

The choice between a human or robot managing your money depends on an investor's desired outcome from the relationship.

Johnson stated that he believes robo-advisors are beneficial as they offer more investment options to investors. He added that he dislikes the idea of a world where individuals are restricted to investing in only one way.

Disclosure: NBCUniversal and Comcast Ventures are investors in Acorns.