Is a Robo Advisor Better Than a Financial Advisor?

A robo advisor is a digital financial advisor that uses financial algorithms to build and manage an investing portfolio based upon your needs, time horizon, and risk tolerance. When you sign up to use a robo advisor, you will be asked a series of questions related to your investing and financial goals.

Based upon your answers to these questions, the robo advisor will choose investments that are right for you. Typically, these investments are made up a low cost investment funds such as mutual funds, index funds, and ETFs. Robo advisors have become increasingly popular due to their low costs and hands off investment management style.

Traditional human fianancial advisors, or planners, focus more on creating a comprehensive financial and investing plan for you. Like robo advisors, financial advisors can also help you choose investments. They can also help you create a budget, helpy you become more tax efficient, help you create an estate plan, and more.

You can hire a financial advisor on a temporary or long term basis depending on what you need help with.
In general, most financial advisors meet with their clients in person at their office to develop a relationship with them and understand their needs. However, there are some financial advisors that will do virtual appointments if there are no good advisors in your area.

Where they shine

The obvious place that robo advisors shine is in their low costs. The average robo advisor charges an annual fee between 0.25% and 0.50% per year. Some robo advisors, such as Sofi Automated Investing, do not charge a fee at all. Traditional financial advisors typically charge about a 1% annual fee.

Although this difference is small, the larger fee of the financial advisor can significantly eat way at your returns. Beyond low costs, robo advisors shine in their ease of use. It is really simply to use a robo advisor as it eliminates the need to choose and manage your own investments.

Where they fall short

Robo advisors don't and can't create a complete financial plan. Since robo advisors focus on low costs and ease of use, they don't offer a complete range of financial services. If you are just looking for basic help with investment management, this is not a big deal. However, if you want an in depth financial plan, robo advisors are going to be a disappointment.

Where they shine

Where robo advisors fall short, financial advisors shine. Financial advisors are there to create a complete financial plan for you. Like a robo advisor, it is a benefit that financial advisors can help you choose the investments that are best for you depending upon your age, goals, and risk tolernace.

However, what you are really paying for is an all inclusive financial package. A financial advisor can help you create a plan to pay off bad debt, reduce taxes through a variety of strategies, create an estate plan, and much more.

Where they fall short

Since financial advisors offer more services than robo advisors, they charge higher fees. The average fee for most financial advisors is typically around 1%. This means that you would pay a $10,000 fee per year on every $1 million that your financial advisor managed. Fees can vary from advisor to advisor. Additionally, many financial advisor require a minimum investment to work with them.

This amount can vary, but some advisors require $100,000 in available funds in order to work with them. Many new investors do not have this amount laying around. So, in order to work with a financial advisor, you have to build that amount up on your own. There is a work around to this problem however, which we will get to later on.

The first and most obvious way to choose between a robo advisor and a financial advisor is to think about how much help you need. If you just need basic investment management, a robo advisor can be a great low cost option.

Many financial advisors will say that robo advisors are not a good option for anyone as they can't create a complete plan. Although this is true, lets think more about why a financial advisor would say this. Its obvious. They want to be able to charge you fees as opposed to the robo advisor being able to charge you fees.

If you think you will need help beyond basic investment management, a financial advisor may be a better bet. Ask yourself some of these questions to help you decide if you truly need a financial advisor. Do you need help creating a budget? Do you need help creating a plan to pay off bad debt? Do you need help creating an estate plan? Do you want to be more tax efficient with your investing?

How robo advisors make money off of you

1) Annual fee

Robo advisors primarily make money off of annual fees. These fees are usually a percentage of the assets under management (AUM) that you have with the robo advisor. So, if a robo advisor charges a 0.25% fee and you have $100,000 in assets through the robo advisor, you would pay $250 in fees per year. Although most robo advisors charge annual fees as a percentage, some charge a flat monthly fee for smaller account balances.

2) Flat rate add ons:

Although it is uncommon, some robo advisors do offer additional financial services for a flat rate that you can add onto the normal investment management. For example, at Betterment, you can schedule a one time meeting with a licensed financial advisor for a flat rate.

How financial advisors make money off of you

1) Percentage fee of assets under management

Similar to robo advisors, the most common way that financial advisors get paid is through a fee of assets under management (AUM). Most financial advisors charge around a 1% fee, but this can vary depending on the advisor. So, at a 1% fee with $100,000 in assets under management, you would pay a $1,000 fee to your advisor.

2) Hourly

Some financial advisors will also offer their services on an hourly basis. In this scenario, you would only pay your financial advisor for the actual time that he or she spends working with you to create your financial plan.
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3) Flat fees

You may also find advisors that charge a flat fee for their services. You can look through what your advisor offers and select the services that you need. For example, financial advisors might package a variety of retirement service together and charge a flat fee between $2,000 and $5,000 per year.

4) Commissions

Finally, some advisors do get paid a commission when they recommend an investment for you. For example, say you had $100,000 to invest with your financial advisor. Your financial advisor recommends a mutual fund that has a 1% commission. In this scenario, your advisor would make $1,000 off of a commission fee and your remaining $99,000 would then be invested.

How to think through if the costs are worth it

1) Financial advisors vs robo advisors - consider their performance

So, robo advisors are cheaper and human advice is more expensive. You might be asking yourself if the human advice is worth paying the extra cost. The first way to think through this is to consider how robo advisors and financial advisors perform. In other words, what return are you getting as an investor through a robo advisor and through a financial advisor?

Lets think through how robo advisors perform. Robo advisors primarily focus of passive instead of active investing. Basically, robo advisors focus on investments that try to match the performance of the market and not try to beat it. The stock market has historically averaged a 10% return. This means that a robo advisor will most likely provide a return of around 10% over a long enough time horizon.

Now, if a financial advisor can get you a return greater than the standard return of the stock market, it might be worth paying the extra fee. In other words, if your financial advisor could get you a 12% return, you could justify paying the higher fee.

However, in all reality most financial advisors do not end up beating the market, even if they say they will. This is not to say that it can't or does not happen, but it is quite rare. Even if an advisor does have a year or two where they beat the market, it will be almost impossible to replicate that over 20, 30 or 40 years.

2) Ask yourself how much help you need again

If its true that financial advisors don't normally outperform the market, and they still charge a higher fee, you might be wondering if paying a financial advisor is worth the cost. However, simply evaluating a financial advisor solely based on their performance is a bad strategy.

As we previously stated, you are paying a financial advisor for a range of services to help create a plan that is right for you. If you need lots of financial help, it can still be worth it to hire a financial advisor.

Finally, you should think through accessibility. In other words, are you able to use a robo advisor today? Are you able to use a financial advisor today? The easier and faster you can start using one of these two options, the more accessible it is to you.

Robo advisors are obviously more accessible. This is one of the main reasons that robo advisors have become so popular. Everyone can invest with a robo advisor, as opposed to just those with a few hundred thousand dollars. Financial advisors on the other hand are not as easily accessible for many people.

This is primarily due to the fact that many financial advisors require a large amount of availble funds just to get started. This amount could easily be in the $50,000 to $250,000 range. Some financial advisors do not require any available funds to get started, but in general robo advisors are more accessible for most people.

Option 1: Only use a robo advisor

You might be at the place where a robo advisor is really all you need. If you do decide to use only a robo advisor, here is what your path forward will look like. You need to choose a robo advisor that is best for you. We will explain how to do that below.

After you have your robo advisor selected, you need to understand what investment account you want to open at your robo advisor. We recommend using a retirement account (specifically a Roth IRA if you qualify) since investing is a long term game. If a Roth IRA sounds confusing or you need more help choosing an account, you can get more information here.

Once you have an account type in mind, you can set that account up at your robo advisor. This process is pretty straightforward and will probably only take 15 minutes. Once your account is approved, simply make your first contribution and stay consistent with your investing.
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Option 2: Consider a hybrid approach

Since robo advisors have become so popular in the last decade, you might enjoy a hybrid approach. A hybrid approach means that you would use both a robo advisor and financial advisor to accomplish your financial goals. Under this method you would get the low costs, accessibility, and ease of use with the robo advisor, while also have the human touch of a financial advisor.

Many brokers, such as Charles Schwab, that offer financial advice also offer a hybrid option by having an in house robo advisor. If you do want to take a hybrid approach, you would first follow the steps in Option 1 to use a robo advisor.

Once your account balance at your robo advisor is large enough to get started with a financial advisor, you can start looking for a financial advisor. If you find an advisor that you like, you can take some of the money from your robo advisor and transfer it over to your financial advisor.

How to choose a robo advisor

The easiest way to choose a robo advisor is to pick one we have already reviewed. You can see our list for the top robo advisors here. Each of these robo advisors is reputable. You can consider things such as fees, features, customer support, and account types to help you make your decision.

Option 1: Start with a financial advisor right away if you are able to

If you are able to and it fits your needs, you can start using a financial advisor right away. The earlier you are able to connect with a financial advisor, the longer you will have to implement the financial plan built by your advisor. As we have stated several times before, most financial advisors do require a minimum amount of available funds. If you do not have the funds needed right now, but would still like to work with an advisor, go on to Option 2.

Option 2: Use a robo advisor until you are able to use a financial advisor

If you don't have the funds available to work with a financial advisor right away, you can still get started with a robo advisor. A robo advisor will still be a good way to invest at a low cost. Once you have built up the amount you need to work with a financial advisor, you can take the funds from your robo advisor and transfer them over to your financial advisor.

How to find a financial advisor

The first way you can find a financial advisor is by asking friends and family. There is probably someone in your circle who works with an advisor that they would recommend. The second way you can find an advisor is by doing a Google search.

If you live in a decently populated area, chances are there are some financial advisors near you. We recommend looking for advisors that have at least a 4 star rating. Finally, you can use a financial advisor locating service.

Essentially, there are companies (such as Zoe Financial) that will vett and find an advisor that is right for you. When you use one of these companies, you start out by answering some basic questions. Based upon your answers, you will be connected with an advisor that is right for you.

Questions you should ask your chosen financial advisor:

Once you have assembled a list of potential advisors you need to vett them. Hiring a financial advisor is basically like conducting a job interview. You need to make sure that the person who is handling your money and future life is qualified and is right for you. You can use the following questions to sort the good advisors from the bad ones.

1) Are you a fiduciary?

A fiduciary is someone who acts in the best interest of their clients. You want to make sure that your financial advisor has your best interest in mind. If your advisor is not a fiduciary, they don't always have to recommend what is best for you, but instead what is "suitable" for you.

2) How do you get paid?

You want to understand how your advisor is compensated. A good financial advisor won't be afraid or hesitant to disclose this information. We already reviewed the ways financial advisors get paid, but you want to find out if your advisor makes money on commissions.

Commissions can create a conflict of interest. Your advisor might be paid for placing your dollars in a certain investment, but it does not always mean that that investment is best for you. We are not saying that it is wrong for advisors to make money off of commissions, but instead to be aware of it.

3) What are your qualifications?

Most financial advisors do have a college degree in some related field. It is a good idea to ask questions about their background. Additionally, advisors are required to obtain certain licenses to give advice and manage your money. You can ask if the have things such as a Series 63, Series 7, or CFP licenses.

4) What is your investment philosophy?

You also want to make sure that you and your advisor have a similar investment philosophy. If you want to buy and sell stocks in the short term, and your investor wants to hold them over the long term, it is probably not going to be a good fit. Get an idea on what they believe about investing and money as a whole.

The bottom line is that both robo advisors and financial advisors can be integral parts of your financial plan depending upon your needs and goals. Robo advisors are cheaper, easy to use, low effort, and accessible. Financial advisors can create a complete financial plan that robo advisors can't. Is one ultimately better than the other?

The short answer is that it depends. Using a robo advisor while you are young and don't have lots of money can be a great option. As your financial circumstance changes with your age, a financial advisor might be a better option. Keep in mind this is not a one or the other situation. You can use both as needed.