Is investing an art or a science? The answer to this question will vary depending on who you ask. Wealth managers and investment advisors will lean towards the artistic side, drawing parallels between what they do and the creative process of artists. If art is the expression and application of creative skill, then it becomes possible to understand how wealth managers use their knowledge and skills in creative ways, connecting disparate pieces of information to reap positive economic returns for their clients.
If you ask economists and market analysts the same question, they will favour the scientific approach to investing. These experts will draw on statistics and cutting edge research to illustrate how passive investing, which is the process of limiting the amount of buying and selling within a portfolio, yields higher returns over time. Proponents of this system often explain how buying index funds that follow one of the major market indices, like the S&P 500 or Dow Jones, yield better long term results than permitting a portfolio manager to take advantage of short term price fluctuations in the market, a process known as active investing.
As a recent addition to the financial services industry, robo-advisors are firmly situated on the scientific side of the scale. They consist of online services that utilize specialized software and proprietary algorithms to make investment decisions on your behalf. Unlike pure passive investing, modern robo-advisors can make adjustments to your portfolio as your situation and the market change. They will collect data about your needs, investment capital and risk tolerance, and determine where best to invest your money. With trillions of dollars already under the control of robo-advisors, should you fire your wealth manager and let a robot make investment decisions for you?
This is the first part of a two-part examination into the advantages and potential pitfalls of relying on a robo-advisor to manage your financial investments.
5 Advantages of Using a Robo-Advisor
1) Affordable Investment Management
It should come as no surprise that personalized service can be expensive. Traditional investment managers charge high fees to manage private portfolios. These fees typically range between 1% and 2% of your annual portfolio value. Robo-advisors generally charge between 0.50% and 1%, with an annual management fee far less than what wealth managers charge.
2) Low Minimum Investment Balances
Professional investment management firms will often demand a minimum investment balance from their clients. This may be anywhere from $5,000 to $100,000 depending on the company and the level of active management that you seek. Robo-advisors have made investing accessible to all, enabling investors with a small net worth to gain access to professional management services.
3) Algorithms Backed by Nobel Laureates
Many robo-advisor platforms, such as Betterment and WealthSimple, rely on scientific models that are backed by Nobel prize-winning research. From 1990 Nobel Prize winner Harry Markowitz to 2013 winners Eugene Fama and Robert Shiller, robo-advisors use cutting edge investment research to drive the growth of the financial assets under their management.
4) Ideal for Novice Investors
We all know that investing for the future is important. It’s a message that has been deeply embedded in our minds from an early age. Unfortunately, investing is complicated. Should you purchase stock or invest in real estate? What about emerging markets and ETFs? Perhaps buying mutual funds and bonds would be a safer alternative? Despite the fact that we would all like to reap the benefits of investing, few of us possess the knowledge and discipline to do it effectively. Robo-advisors are perfectly suited to help new investors. With low minimum deposit requirements, you can focus on growing your investment capital while your digital advisor manages the day-to-day details of your portfolio.
5) Superior Tax Efficiency
Taxes have a major impact on your investment rate of return. For this reason, robo-advisors strive to invest with a high degree of tax efficiency. They do this by relying on low cost index-based exchange traded funds, or ETFs. These funds rarely trade securities which generate taxable capital gains. Robo-advisors also offer tax-loss harvesting, which is an investment strategy whereby capital gains are offset through the sale of investment positions that have experienced losses.
Stay Tuned for Part 2
Next week, we will explore the disadvantages of relying on robo-advisors for your investment needs. We will also offer insight into whether you should retain the services of a financial professional or embrace technology and use a robo-advisor to help guide your personal investment strategy.
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