This post compares hiring a robo-advisor vs. DIY investing for younger investors with straightforward finances.
You might be in your late twenties, early thirties. You’ve spent the past few years earning promotions or getting higher paying jobs. As evidenced by the chunk of cash collecting dust in your checking account, you’re earning more than you’re spending. You’re ready to invest.
So, should you manage your own portfolio or hire a robo-advisor? If you’re younger and have a relatively straightforward financial situation, you have choices.
Here’s what I’d consider.
How Robo-Advisors Work
When you hire a robo-advisor, a website manages your investment portfolio with little to no human intervention.
You answer a questionnaire. Then, based on your responses, the website determines what type of account and stock/bond mixture suits you best. More often than not, a robo-advisor will invest your money in a portfolio of index funds.
The robo-advisor manages your account on an ongoing basis. No logging in to trade. No rebalancing. No lost sleep worrying if you bought at the perfectly wrong time. Anyone who suffers from analysis paralysis appreciates the gravity of what you’re outsourcing.
Your jobs are simply to (1) continue contributing money and (2) keep your investor profile updated with your financial deets. For instance, if you’ve had a change of plans, and now you want to use your money to buy an RV and travel the country in three years instead of ten, let the website know. That can change how the robo-advisor invests your portfolio.
A robo-advisor that I like is Wealthfront. You’ll get a best-in-class portfolio of index funds, and the management fee they charge is extremely competitive at 0.25%. (This is not an ad.)
The Cost of a Robo-Advisor vs. DIY Investing
A self-managed portfolio of index funds will cost between 0.05% and 0.25% of your account value per year, on average. These are the “expense ratios” charged by the underlying funds or ETFs you hold. As long as you pick low-cost options, expense ratios can be minimal. There’s no way around them, unless you’re going to pick stocks yourself. That, I’d argue, isn’t worth your time.
Robo-advisors usually build their portfolios with index funds, too. Additionally, they charge a management fee to oversee how much goes into those index funds on an ongoing basis. Management fees run in the range of 0.25% to 0.50% of account assets per year. They’re in addition to the expense ratios of your underlying investments.
On a 100,000 portfolio, an estimate of the annual cost of a robo-advisor vs. DIY investing is:
- Robo-Advisor: $300 to $750
- DIY Investing: $50 to $250
The Value of Robo-Advisors
Hiring a robo-advisor has the following benefits:
- Saves the effort up front you’d expend researching investments.
- Eliminates the constant Am-I-doing-this-right!? worry.
- Manages your account on an ongoing basis.
- No (or very small) investment minimums to get started.
- Access to a professionally-managed portfolio, usually constructed with index funds.
Now, you might be wondering why someone in their right mind would pay a robo-advisor to build an otherwise identical portfolio of index funds that you could build yourself.
If you’re scratching your head, humor me by following this analogy. Hiring a robo-advisor is not unlike deciding to buy a classic chocolate chip cookie at a bakery instead of baking one at home. 🍪
Sure, you’re paying a premium for your bakery cookie, but you know it’ll meet a certain standard. Plus, you wasted no time researching a recipe, measuring out the ingredients, and running the risk of your cookies coming out like a Pinterest-fail.
(How does that famous quote go? One bakery cookie in hand is worth two in my oven? I’m really mixing metaphors today between investing, cookies, and medieval falconry.)
Anyway, if you enjoy the process of baking, it’s logical to make your own cookies. Similarly, if investing interests you, roll up your sleeves and give it a shot. But, if that’s not you, there’s no shame in buying the finished product. That’s exactly what a robo-advisor portfolio is.
Shortcomings of Robo-Advisors
You’re hiring a robo-advisor to perform one specific function: manage your investment portfolio.
Your new robot friend isn’t going to tell you when to contribute to what type of IRA, which can maximize your tax savings. They’re not going to coach you through down markets when you’re anxious and tempted to return to the safety of cash at the worst possible time. They won’t answer your questions or build your financial plan.
Robo-advisors also won’t beat the market. Even though you’re getting quality investment management with a robo-advisor, that means you’re getting index fund returns without taking more risk than you need to take. Paying them a fee doesn’t mean you should expect outsized returns.
The Case for DIY Investing
I’m confident anyone can manage their own portfolio. If you’re shaking your head in denial, let’s make sure you have the right vision.
What I mean by “DIY investing” is picking a portfolio of low-cost, diversified index funds to buy and hold for the long-term. This takes some work up front to get acquainted with the basics of investing and research your first investments, but then the hard work’s done.
You can build your portfolio so it’s extremely simple to upkeep.
An easy yet effective way to do this is investing in one singular ETF or mutual fund. (Yes, you read that right.)
If you’re in your 20s or 30s and have the risk tolerance to be an all-equity investor, all you may need is one global stock market fund to complete your portfolio. (Several of my personal accounts own Vanguard Total Stock Market Index (VT) alone.) Or, if you’d like your portfolio to automatically de-risk as you age, you could pick one target date fund.
Funds like these 👆 are fully-diversified, meaning you only need to pick one. Picking one investment outsources future portfolio rebalancing to the professional that manages the ETF or mutual fund you picked. It also removes the friction of trying to decide which investment you should buy when you contribute money to the account.
If you set up an automatic investment program into your one investment, you could realistically expect to check in on your portfolio quarterly. No more.
When I say “DIY Investing,” I’m not referring to picking and managing a portfolio of stocks based on your research. This takes a ton of your time, and you’re unlikely to get a result that’s any better than an index fund.
Related Post: How to DIY a Fully-Diversified, Low-Cost Portfolio
When to Hire a Human
Hiring a financial advisor can be a smart move if your financial situation is growing more complex. This is often the case when you:
- Are a high-earner.
- Have several investment accounts and properties.
- Own a business.
- Are starting a family.
- Have enough money to meet advisor asset minimums.
Hiring an advisor isn’t cheap – most charge a fee of at least one percent of portfolio assets each year – but it can be worth it for the advice you get. For example, if you’re a high-earner but have no idea what type of tax-advantaged accounts to contribute to, an advisor’s advice could easily save you five figures on your tax bill.
If you’re in your 20s and 30s and feel like you need a second set of eyes on your financial sitch, my recommendation would be to work with a fee-only advisor who builds a financial plan for you. A financial plan serves as your roadmap for what to do with your money over the next several years.
At a human level, a financial plan feels reassuring. At a financial level, it’s worth its weight in gold. From it, you’ll learn what to do with your money each year to be successful.
The Bottom Line
Between robo-advisor vs. DIY investing, one isn’t necessarily better than the other. It comes down to a matter of preference.
If you’re more cost-sensitive and don’t mind rolling up your sleeves to try something new, give DIY investing a try. The work you put in up front will pay literal and figurative dividends over your life.
If DIY investing gives you the money version of the Sunday Scaries, you can nope-out of it by paying a few extra bucks to the robots. For your money, you’re outsourcing a function that doesn’t spark joy into very capable (cold, metal) hands.
Finally, realize that whatever you choose isn’t permanent. There’s no harm in hiring a robo-advisor (or a human advisor) for a period of time, learning the ropes, then switching to DIY investing in a brokerage account.
Whatever you choose, I’m so excited you’re getting started!
Related Post: How to Start Investing with $10
The opinions voiced in this material are for general information only and are not intended to provide specific advice or recommendations for any individual. To determine which investments may be appropriate for you, consult with your financial advisor.