Rise of the Robo-Advisor: Things to Consider Before Embracing an Algorithm

Robo-advisors are a relatively new phenomenon, and one that many people are excited about. But don't jump on the bandwagon without some careful thought.

, we covered the advantages of robo-advisors, the emerging technology that is changing the financial services industry. Robo-advisors are automated, algorithm-based wealth management service that uses large quantities of data to try and predict investments that will outperform the market. Chances are you’ve heard a little about them and their advantages, which can include lower fees, powerful computing algorithms, greater access to investment advice for many, and customization.

Of course, no financial services tool is without its drawbacks, and the same is true for robo-advisors.

How much does the human touch matter to you?

There are a few additional disadvantages we’ll mention, but the primary one is that while robo-advisors are customizable, they aren’t personalized. That is, the algorithms can be programmed for many variables, but they cannot take into account your personal situation. For the most part, they also won’t take into account your entire financial picture, though some of the more robust versions will seek a lot of input from you.

Perhaps more importantly, robo-advisors don’t provide the human touch. One won’t call you after a market down-turn to reassure you that your long-term buy and hold strategy still applies. The robo-advisor won’t sit across from you with a cup of coffee and detail why it made certain investment decisions, and it most likely won’t integrate your tax concerns, insurance concerns, estate plans, and other factors a human advisor is more likely to consider. For now, most robo-advisors are not equipped to handle more complicated transactions, like calls, puts, spreads, and straddles. (If you don’t know what those last four things are—they’re options transactions—chances are this won’t be a big obstacle for you.)

For many dentists looking for a simple savings and investment strategy, the services provided by a robo-advisor will be perfectly acceptable. For others, you know who you are. Also consider the following:

• All things equal, a robo-advisor will be cheaper to work with than a human financial advisor. But most robo-advisors do bring their own fees. Advertising around robos tend to overestimate the cost of working with a financial advisor, so buyer beware.

• The technology is relatively new. While the algorithms are robust and the principles behind robo-advisors are sound, there can’t yet be longitudinal studies of their performance versus human advisors, simply because robos haven’t been around long enough.

• Some people use meetings with their advisors as a system of regular check-ups—and perhaps encouragement—to save and invest more. Using a robo-advisor will not work for this purpose.

The drawbacks of working with a robo-advisor may not seem that substantial, but they really boil down to what kind of investor you are and how much hand-holding you’ll need. This is a very personal question, and the answer has to be right for you. Just be sure you understand the advantages and disadvantages before changing your approach.