The time has come to let a robot handle your money.
I know, I know. Handing the keys to your portfolio to the investing equivalent of Siri sounds either really stupid or too good to be true. But the reality is, in the past few months, what was once an experimental Silicon Valley curiosity, “robo investors”—newfangled software that manages your holdings, originally developed by scrappy startups—has gone mainstream. Even major financial companies, including Schwab and Vanguard, have begun offering automated investment advice.
And the investing masses, fresh off the most recent market crash, couldn’t be happier. A recent Schwab survey found that 40% of millennials and Gen Xers would prefer a portfolio based on a computer to one based on a human adviser’s decisions.
Of course, this is all pretty crummy news for hack brokers, but it’s terrific news for you. In many ways, robots are the ideal investors. In fact, they’re probably the most levelheaded dudes on Wall Street: They don’t suffer from fear or greed—the source of most money mistakes—and they don’t charge much. And, unlike the debauched schemers working for Leonardo DiCaprio in The Wolf of Wall Street, they won’t sell you worthless penny stocks, snort coke, or bang prostitutes on their desks.
Now, for many people, hiring the right (human) financial adviser is still the smartest money move they can make (and, for the record, I highly recommend it). But good advice is often expensive, and not everyone has the time or energy to find the “right” person and start a “relationship.” Frankly, in the time it will take you to read this article, you could’ve opened a robo account and started investing in ways your father could only have dreamed of. Of course, that’s if you know what you’re doing.
So whether your goal is to pay for retirement, buy a house, or just build wealth, here’s your guide to the investing of the future.
Increase your artificial intelligence
Estimates of the number of robo firms vary widely, from research firm Morningstar’s 37 to The Wall Street Journal’s 200. But whatever the figure, it will be smaller after the next market crash, as weak players go belly up or get taken over by the big guys. Tricia Rothschild, an expert on robo advisers at Morningstar, suggests looking for a “financially viable” firm.
That’s easier said than done, but you can have confidence in the giants, Schwab and Vanguard; the pioneers, Betterment and Wealthfront, are well-funded, and—for now at least—benefit from first-mover advantage.
While the portfolios differ, the basic investment philosophy behind all of them is the same. Rather than try to pick stocks or other assets that will beat the market, they spread their bets widely among stocks and bonds around the globe, which smooths the ride since some investments tend to rise while others fall. Most of them periodically rebalance to the original asset allocation, which requires selling things that have done well and buying more of the duds. That’s a winning strategy over the long term, but it’s painful and counterintuitive, so it’s a lot easier to execute if your brain is made of transistors instead of neurons.
Some human advisers build similar portfolios, but they tend to charge around 1% or more. Many will choose more expensive funds as well, adding to the total cost. In fact, price may be the robos’ single biggest advantage. Without hard numbers, it’s tough to understand how much cold, hard cash you’re giving up by paying even a small difference in fees.
Here, let me show you how it works
I went to betterment.com, one of the trailblazers of robo advising, and started the stopwatch.
I entered information for an average Men’s Fitness reader–let’s say, age 30, income of $80,000. In less than 60 seconds I had a portfolio of 10 investments, consisting of 10 Vanguard exchange-traded index funds, with 90% in stocks and 10% bonds, in more than 5,000 publicly traded companies from more than 100 countries. There are no salespeople with hot tips—and index funds, by definition, don’t even try to beat the market. The cost: a dirt-cheap 0.25%, or $120 a year for a $50,000 portfolio.
To be sure, we could analyze that portfolio to death. Is it too aggressive? Do I really need 10 funds? Smart, well-intentioned humans could make good arguments for a slightly different approach. And the portfolio would have been refined if I’d actually opened an account and answered some more questions. But here’s the thing: We could debate your workout, your diet, and probably half the decisions you make at the office. What can’t be debated is that there are countless worse investment plans and an equal number of ways to piss away your extra cash.
And here’s why fees are so important: Consider a $50,000 account that earns an average of 7% through an adviser whose fee, plus the fees on his underlying funds, add up to 1.5% a year. (That’s on the cheap side.) Assuming no more investments in that account, at age 65 the investor would have $314,500. At a robo total fee of 0.5%, given the same rate of return, his account would be worth $448,000. That mere 1% a year would reduce total returns by $133,000.
So, here’s your rule of thumb: Try to avoid paying more than 0.3% as a fee, and don’t choose a robo adviser if the recommended portfolios include more than one or two funds that charge more than 0.25%. (Some foreign funds, especially emerging markets, can be pricey, but a U.S. stock ETF should charge 0.10% or less.) Be skeptical, however, if an offering is completely free—financial companies aren’t in business to lose money. Plus, it’s always better to know what you’re paying than to have hidden costs eating away at your future fortune.
Know your risk
For all their advantages over humans, robots do fall short in some ways. Most notably, robots make lousy psychiatrists, a crucial role when the market goes crazy. One Vanguard study even found that advisers added, on average, 3% a year to investors’ returns, in part by simply preventing them from doing dumb things.
For instance: You can be sure that the market will crash one of these days, so try to imagine your reaction if your $50,000 account is suddenly worth $26,000. If you feel the impulse to sell and wait for a “better time” to get back in, you’ll need some hand-holding, so consider Vanguard or Personal Capital, which have advisers monitoring your account.
Humans also come in handy when life gets more complicated. Add a wife, kids, some real estate, and a couple of retirement plans to your financial situation and you need more than a smart mix of index funds.
According to Rothschild, some financial advisers are themselves using robos to handle their clients’ investments so they can focus on all the things a robot will never understand.
If you do stick to robos, however, here’s your action plan for the next time the market starts going haywire: Leave the robot in control. You’ll then be the guy buying stocks at a discount from the panicked sellers—thanks to your robo buddy.
My final tip: Remember that this account isn’t for money that you might need to pay bills or even tap in an emergency. It’s money for the future.
Who knows? Maybe then you can buy a real robot.
Jack Otter is the author of Worth It…Not Worth It? Simple & Profitable Answers to Life’s Tough Financial Questions.