Self-Directed Investing Vs. Robo-Advisors: Where Should You Put Your Money, And Why?
July 16, 2018
Investing with a robo-advisor is a massively popular alternative to having an actual financial advisor, but is it a good alternative to investing your own money?
Slowdown. What’s a robo-advisor?
Basically, a robo-advisor is a service where you put your money in an account and sit back while a computer makes all the investment decisions. These platforms will have you answer a few questions to find out how much risk you can handle and then use algorithms to invest your money – primarily in ETFs. If you’re curious why they focus on ETFs or what an ETF actually is, here’s a quick read. So if robo-advisors make investing super easy and significantly cheaper…why would anyone risk investing on their own?
Why would you make your own investment decisions?
A common reason for investors to avoid a robo-advisor and make their own investment decisions is simple: they like to. Tons of people enjoy researching and choosing their own stocks; identifying potential winners, and actively having a say in their portfolios. You can’t do much of that with a robo-advisor as it would defeat one of their major goals: to separate investing and human emotion. If you’re confident in your basic investing knowledge – you know how to buy a stock and how much to allocate to each stock – then you may want to get your hands dirty.
Another reason is out of interest in learning about the stock market. If you hope to learn and grow as an investor you may want to stay away from a robo-advisor. You will learn exponentially more from the invaluable experience of investing on your own or in an investment club than you will from handing your money over to an algorithm.
This is the most common reason:
If you are like most investors, you want to beat the market and earn higher returns than the S&P 500. To have a chance at beating the market, many would argue that you have to invest on your own. This is because a robo-advised portfolio is designed to match the performance of the market. These portfolios often advertise that they can beat the market, but they have proven otherwise, bringing modest returns to investors. In reality, it’s difficult to outperform the market for an individual, but at least you will have the opportunity to do so.
Two last points:
- Robo-advisors can be limiting, giving you less freedom to invest in certain assets such as REITs and some ETFs
- Robo-advisors as we know them today have only been around since 2010. Because of that, there’s not much data that can tell us how they will perform when the market is down. After all, they are designed to follow the market…
After that one-sided argument, let me try and dissuade you.
Why on earth would someone invest with a robo-advisor?
There are tons of advantages that you can gain from investing with a robo-advisor.
One of the biggest reasons someone would invest in robo-advisors is that they take emotion out of the investing equation. We are not rational beings. Either by greed, a lack of knowledge or a combination of other factors, we fall victim to tendencies such as buying high and selling low. Consider those who bought bitcoin at its peak. Economic bubbles like this one have repeated themselves throughout history because human emotion keeps getting in the way. A robo-advisor follows the book. Period.
If you’re busy you might not have time to actively invest. Investing is time consuming: requiring you to adjust your portfolio frequently, stay up-to-date with the markets etc. etc. While there are tons of ways to make investing less time consuming (one of the 7 reasons why investing is better with friends) a robo-advisor practically eliminates the time requirements.
If you don’t really care about investing or you don’t know much about the stock market…well, first of all, consider learning, but second of all, you can still invest using a robo-advisor. You don’t need any market knowledge. You can sign up, throw your money in and forget about your portfolio until the end of time.
Lastly, investing with a robo-advisor is almost always cheaper than investing on your own. To start with, there are lower fees. More interestingly (depending on who you ask), robo-advised portfolios practice something called tax loss harvesting. This constantly balances the books to increase your portfolio returns, sometimes by upwards of 1.5% (according to Wealthfront).
If this sounds like your cup of tea, you could check out the best robo-advisors of 2018.
There are many different types of investors with different motivations; from day-traders to those who don’t know a single stock in their portfolio. And thanks to robo-advisors, the latter group can occasionally do better than the former.
If you want to have an active role in your investments, you possess some knowledge, you’re interested in learning more and you are after high returns, you should make your own investment decisions.
If you are not interested in having control of your investments, you lack time to manage an investment, you’re risk averse and you want to avoid investing emotionally, you should consider investing with a robo-advisor.