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Q&A: Should You Use a Robo-Advisor?

You can, but you'll likely get what you pay for.

Question: I’m 20 years old and am a pretty good saver. I have about $1,000 that I’m willing to invest in a Roth IRA now, and I plan to contribute about $200 to $300 a month to it after I open it. I know of a couple of online companies where you just state your risk tolerance on their web form and they invest your money for you, showing you how they will diversify your portfolio. What is your view of that? 

Ric: Online investing sites are certainly options. There are now dozens of them in the marketplace, including the one my firm offers, Edelman Online. The technology has become routine.

When you invest online, you are working with a risk-based model, as you noted. That means you’re asked questions about your attitude toward risk. If you say you don’t want a lot of risk, you may be offered a portfolio that has most of its money in bonds; if you say you are willing to accept substantial risk, the recommended portfolio will likely contain mostly stocks.

This approach is very different from what happens when you get advice from a human financial planner who is experienced in investment management and can provide a personal touch. When my colleagues and I talk with our clients about investing, we discuss not merely risk, but also something even more important: your life goals.

Indeed, we strongly believe that goals-based investing is far more valuable to you than risk-based investing.

You see, if we are selecting investments to achieve certain goals, risk becomes a secondary issue. I’m not saying risk doesn’t matter — it certainly does. But let’s say you told me, “I want to engage in a risk-based travel plan.” I might ask, “How do you feel about flying?” And you might say, “I don’t like to fly. Flying makes me nervous.” My answer would be, “Well, then, I’m going to recommend taking a train.”

That’s a risk-based model. But if you are traveling from New York to Los Angeles, you’re now stuck on a train for four days — and you might miss the event that’s causing you to make the trip.

But if we were using a goals-based model, I would ask, “What is your goal?” And you might say, “I’m in Connecticut, and I want to be in San Francisco tomorrow.” I’d reply, “If that’s your goal, you must board a plane.”

Even though you might be nervous about flying, taking a jet is the only way you can achieve your goal. So we’d try to choose an air carrier that meets the Federal Aviation Administration’s highest safety standards, has a great safety record, and uses planes that feature two pilots and two engines (many planes have only one of each). We might even send you to your doctor, who can decide whether you need a prescription to help you stay calm during the flight.

In other words, we’ll address your risks, but in a way that still helps you to achieve your goals.

Online investment sites can’t do this for you.

Those sites also can’t tell you whether you’re making any mistakes. For example, many online sites don’t ask whether you have credit card debt (if you do, you should pay that off before investing). They can’t answer questions about homeownership or mortgages, employee benefits at work, leasing or buying cars — or any of the other questions affecting your efforts to achieve financial success.

And, most important, online sites can’t help you when you get nervous during market declines.

So if you’re not interested in comprehensive financial advice, go ahead and consider an online investment site. They’re typically inexpensive. But I suspect you’ll eventually conclude that you’re … getting what you paid for.

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