Automated investing platforms, sometimes called "robo-advisors," are becoming a familiar part of the investing landscape. Even so, many investors have questions about these services—and what the possible advantages of using them might be.
In fact, an automated portfolio can play a number of potential roles in your financial plan. "Automated investing services are designed to be broadly applicable to a wide variety of investors and goals," says David Koenig, chief investment strategist of multi-asset solutions for Schwab Asset Management Solutions.
You can set up multiple accounts to invest for multiple goals—each with its own time horizon and risk profile.
Automated investing overview
As you've probably heard before, automated platforms are engineered to simplify the investing process. But robo-advisors are also known for providing diversified portfolios at low cost. Typically, you begin by filling out an online questionnaire that identifies your goals and time horizon and gauges your risk tolerance. Next, this information is run through an algorithm that recommends a portfolio of diverse assets. It may sound high-tech, but the portfolios and their underlying investments—often low-cost exchange-traded funds (ETFs)—are selected by investment professionals. Meanwhile, the automated features help streamline complex tasks like rebalancing (to make sure your desired allocation stays consistent over time); tax-loss harvesting (to help offset taxes on gains and income); and setting up a steady income stream in retirement.
Here are five ways you might incorporate an automated investing service into your financial strategy. Keep in mind that you'll usually set up an account to focus on a specific goal—so your answers to questions about your objective, time horizon, and risk tolerance need to pertain to that goal.
Goal #1: Save for a second home
Because an investing portfolio has more potential for higher returns than an ordinary savings account, it can help you work toward a longer-term goal like a second home. How you fill out the questionnaire will determine how conservative or aggressive the portfolio allocation recommended by the service will be, David notes.
For example, if your time horizon is relatively short and you have a relatively low risk tolerance, your second-home fund could use a conservative allocation that emphasizes bonds and cash. By contrast, a more aggressive portfolio might include more stocks. Depending on your risk tolerance, the portion allocated to various asset classes may vary, but your portfolio would still have more potential for growth than a savings account.
Of course, there are risks. Using an investment account would expose your savings to potential market volatility and investments could lose value. And even if your portfolio thrived, you could end up with capital gains and their attendant tax bill. However, the potential for higher returns and the automated nature of these accounts may still make them attractive vehicles.
Goal #2: Save for college
The go-to college savings vehicle for many Americans—the 529 plan—comes with some restrictions. But you may be able to work around these by using an automated portfolio. For example, you can't use 529 plans to pay for education at certain institutions outside the United States. If your child's heart is set on the Sorbonne, any distributions from the plan would not be considered a qualified withdrawal.
If your child gets a scholarship and doesn't need all the money you set aside in a 529, you can withdraw an equivalent amount from the 529 without paying the usual 10% penalty for nonqualified withdrawals—but you may still have to pay federal and state income tax on the gains in the account if you cannot use it for another child or other family member.
If you put aside some college savings in an automated investing account, it may not grow tax-free as it would in a 529, but you'll have more flexibility about how you spend the money. And when you liquidate, most of your gains will likely be taxed at the more favorable long-term capital gains rate (depending on the timing of the deposits and withdrawals you made over the years), which is generally lower than the ordinary income tax rate.
So although 529 plans remain a valuable—even essential—tool for college savings, it's worthwhile to consider supplementary ways to save for expenses that a 529 plan won't cover.
Goal #3: Consider consolidating IRAs
Could you use an automated portfolio as the mainstay of your retirement plan? Yes, David says—but you can also consider one for just part of your plan.
Let's say you have a 401(k) with your current employer, but you also have several IRAs you've accumulated over the years. Monitoring and rebalancing those IRAs individually can be a time-consuming task. "An investor might decide to roll all of her IRAs into one automated investing IRA to benefit from the automated monitoring and rebalancing," David says. This can add a certain level of discipline to your plan, he notes.
Goal #4: Organize your portfolio
Once you're in retirement, you might consider using an automated investment advisory platform as part of a "bucketing" strategy—separating out different portfolios for growth and for income generation. For example, you could open one account with a longer time horizon and higher risk tolerance for growth, while a second account could be more conservative and focused on generating income. The potential benefit here is that an automated plan would stay the course and rebalance to your target allocation, even when those decisions might be hard to make on your own.
Goal #5: Generate steady income in retirement
Taking income from a retirement portfolio can be one of the most challenging aspects of financial planning: Draw too much too soon, and you could deplete your savings faster than you can afford. Draw from the wrong assets, and your portfolio might not have enough growth potential to meet your future income needs.
Fortunately, some automated portfolios enable you to create a personalized withdrawal strategy for a steady stream of income that helps you meet your retirement expenses. By setting your retirement income goal, the system can help monitor your portfolio and withdrawals so you stay on track.
The personal touch
Of course, some issues are too complex—or emotionally fraught—and require more personal guidance. "This type of service isn't meant to replace estate or tax planning," David says.
It's also not meant to replace the kind of ongoing, personal relationship you might have with someone you trust, who has come to know your individual needs and concerns over the course of a long relationship.
That's not to say you may not get the benefit of human experience with an automated investing platform. "Some offer investors access to financial professionals either via chat or by phone," says David.
The bottom line: If you're looking for a low-cost, efficient, yet flexible way to invest and you're comfortable with doing it all online, it might be time for you to log on. Whatever your financial goal—a comfortable retirement, graduate school for your son or daughter, or a new car—an automated investing service could help get you there.
The information provided here is for general informational purposes only and should not be considered an individualized recommendation or personalized investment advice. The investment strategies mentioned here may not be suitable for everyone. Each investor needs to review an investment strategy for his or her own particular situation before making any investment decision.
All expressions of opinion are subject to change without notice in reaction to shifting market conditions. Data contained herein from third-party providers is obtained from what are considered reliable sources. However, its accuracy, completeness or reliability cannot be guaranteed.
Investing involves risks including possible loss of principal.
A rollover of retirement plan assets to an IRA is not your only option. Carefully consider all of your available options which may include but not be limited to keeping your assets in your former employer's plan; rolling over assets to a new employer's plan; or taking a cash distribution (taxes and possible withdrawal penalties may apply). Prior to a decision, be sure to understand the benefits and limitations of your available options and consider factors such as differences in investment related expenses, plan or account fees, available investment options, distribution options, legal and creditor protections, the availability of loan provisions, tax treatment, and other concerns specific to your individual circumstances.
There is no guarantee that an income goal can be attained, nor that the duration of future withdrawals associated with that goal, will be reached.
This information is not intended to be a substitute for specific individualized tax, legal, or investment planning advice. Where specific advice is necessary or appropriate, Charles Schwab & Co., Inc. ("Schwab") recommends consultation with a qualified tax advisor, CPA, financial planner or investment manager.
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Diversification, automatic investing, and rebalancing strategies do not ensure a profit and do not protect against losses in declining markets.0521-1BKC