Robo-Advisors Part 2: Pros, Cons & Pitfalls to Watch Out For
Carter, aren’t robo-advisors your competitors? Don’t you worry they’ll replace you?
The reality is: robo-advisors fill a much-needed gap in the financial services industry and can be a great fit for the right person. My job isn’t to push you into something you don’t need. There’s no one-size-fits-all solution in financial planning. Let’s break down where robo-advisors shine, where they fall short, and a few pitfalls that aren’t always obvious at first glance.
Be sure to check out Robo-Advisors Part 1: What Are They & Should You Use One before reading on.
The Pros of Robo-Advisors
- Low cost: The average fee is around 0.30% per year. This is typically lower than a financial advisor would charge.
- Behavioral guardrails: They create a layer between you and your money, helping reduce impulsive investing decisions. When the market inevitable goes up and down on news (or no news), you will inherently want to react. However, usually you're reacting too late and may be getting in the way of long-term growth.
- Tax alerts: When buying and selling holdings in a taxable account, they’ll flag potential capital gains/losses to stay tax-efficient.
- Modern and user-friendly: Intuitive apps and interfaces make it easy to invest.
- Rules-based investing: Contributions and rebalancing happen systematically - no “market timing” required.
- Built-in diversification: Portfolios are designed to match your desired level of risk.
The Cons of Robo-Advisors
- Limited human touch: Even when they offer access to human financial advisors, they may be handling thousands of clients. True personal advice is nearly impossible with this client load and rare.
- Customization is limited: The investment option lineup is often narrow. While saving and discipline matter more than “perfect” portfolios, this limitation still counts.
- Harder to leave: Transfers out can be clunky (think paper checks, missing cost-basis data)... maybe on purpose 🤷.
- Corporate buyouts: If your robo platform gets acquired, your money may land under the control of a large public company with shareholder obligations that may not be in your best interest. This is out of your control, but another reason to factor in the difficulty of leaving mentioned above.
- No comprehensive planning: Taxes, estate planning, insurance, retirement income strategy - these aren’t built into robo platforms.
Three Common Pitfalls
- “Free” isn’t free: Robo-advisors often invest you in their own funds with higher-than-average expense ratios. That’s one way they get paid and make up for the lower 0.30% fee.
- Hidden use of cash: Many require a sizable cash allocation in your portfolio and this creates something called cash drag, the reduction in investment returns caused by holding a portion of a portfolio in low-yielding cash instead of fully investing it in higher-return assets. Why would they do this then?
They take your cash and lend it out, receiving the interest. Some may even invest the cash in fixed-income instruments (U.S. treasuries) and collect the yield (interest). Regardless, this is another revenue stream for robo platforms that is not in your best interest. - Tax loss harvesting hype: One of most advertised benefits of a robo-advisor (that a financial advisor or you as a DIYer) can also do. While it can provide short-term tax savings (selling investments at a loss to gain the tax deduction of capital losses), the long-term benefits are less clear. There’s also the risk of tracking error during the 31-day wash-sale waiting period.
And beware of marketing that promises “low-risk, high-return” strategies. Always look under the hood -understanding the true investments and fees is essential.
Robo-advisors can be a good solution for some investors, especially those who are just getting started or want a simple, rules-based approach. But they also come with trade-offs - limited personalization, cash drag, and marketing that sometimes oversells their benefits. The most important thing is making sure your financial strategy matches your goals, not just what’s convenient or trendy.
If you’re wondering whether a robo-advisor could work for you - or if you’d benefit from a more personalized plan - let’s have a conversation and explore what’s best for your unique situation.
👀 What Caught My Eye
The Consumer Financial Protection Bureau unveiled a rule to cap late credit card payment fees banks can charge at $8 per incident, down from an average of about $32. A reminder that costs - whether bank fees or investment expenses - matter more than most people realize.
“You miss 100% of the shots you don’t take.” - Michael Scott.... I mean Wayne Gretzky
Ready to Take Off?
📩 Have a financial question? Visit The Financial Takeoff and our Ask a Question page.
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Life is short and time is precious. Thanks for taking yours to read this and I hope to be a part of your Financial Takeoff!
Disclaimer: This is just for informational purposes and should not be used or viewed as tax, legal, or financial advice. Work with your tax professional, legal professional, and financial planner to evaluate which strategies would be the best for your situation.
