For today’s investors, personal control and automation often seem like opposing forces. On one hand, self-directed investing offers the freedom to choose and manage your own investment portfolio. On the other hand, robo-advisors promise a hands-off approach, letting algorithms make investment decisions for you.
As you compare these two investment approaches, understanding their differences, advantages, and disadvantages will help you decide which one aligns best with your financial goals and comfort with risk.
Key Takeaways
- Self-directed investing offers more control and the potential for higher returns, but requires a significant time investment and a solid understanding of financial markets.
- Robo-advisors provide an automated, low-effort investing experience, but may limit your investment options and come with their own set of fees.
- The choice between self-directed investing and a robo-advisor depends largely on your personal preferences, financial goals, investment knowledge, and available time.
Robo-Advisor vs. Self-Directed Investing: Key Differences
With self-directed investing, you retain full control over your investment decisions. You decide what to buy, when to buy, and when to sell based on your research, knowledge, and risk tolerance. On the other end of the spectrum, robo-advisors take the driver’s seat. Once you’ve set your financial goals and risk tolerance, these digital platforms use algorithms to construct, manage, and rebalance your portfolio automatically, minimizing your involvement in the day-to-day decision making.
The second point of difference is the level of expertise and time commitment required. Self-directed investing necessitates a strong understanding of financial markets and investment principles. You need to stay updated with market trends and economic news, and be able to analyze potential investments. This requires a significant amount of time, effort, and continued learning. Conversely, robo-advisors require minimal investment knowledge and time commitment from you. The platform handles all the technical aspects, making it a good fit for novice investors or those who prefer a hands-off approach.
Another consideration involves the costs and risks that differentiate these two investment approaches. Typically, self-directed investing can be less expensive, as you aren’t paying for an advisor’s services—especially with commission-free trading offered by an increasing number of brokers. The exception to this is self-directed individual retirement accounts (IRAs), which often come with higher fees than those of other investment accounts.
Self-directed investing carries a higher risk, as the responsibility of investment decisions rests solely with you. Robo-advisors, while usually charging a small percentage of your invested assets as a fee, offer a lower-risk investment approach. Their algorithms are designed to build a diversified portfolio that aligns with your risk tolerance, thereby spreading the risk. However, they may not be able to react to market changes as swiftly or intuitively as a human investor could.
What Is a Robo-Advisor?
At its core, a robo-advisor is a digital investment platform that uses algorithms to manage and rebalance your portfolio. You simply set your financial goals and risk tolerance, and the robo-advisor takes care of the rest. They’re the digital equivalent of an autopilot for your investments.
Over the past decade, robo-advisors have evolved and grown significantly. Initially, they were focused on providing automated portfolio management, but today, they offer a range of services from tax-loss harvesting to retirement planning. Many traditional financial institutions have also launched their own robo-advisory services, recognizing the demand for this blend of technology and financial management. Today, hundreds of robo-advisors are available globally, with billions of dollars in assets under management (AUM). Investopedia has a list of the best-ranking robo-advisors.
Robo-advisors offer a low-cost, accessible investment option, especially for those who are just starting out or prefer a hands-off approach. By handling the complexities of investment management, robo-advisors allow you to focus on setting and achieving your financial goals.
Advantages and Disadvantages of Robo-Advisors
Robo-advisors shine in their simplicity and ease of use. They handle the heavy lifting of investment management, making them great for beginners or those with a hands-off investment style. However, they may not offer the same depth of investment options as self-directed investing, and their fees, while typically lower than traditional advisors, can still add up.
Robo-Advisor Pros & Cons
Pros
Automated, hands-off investing
Low cost
Low minimums
Well-diversified portfolios based on proven strategies
Takes emotion out of trading
Cons
Lack of flexibility
Limited asset class selections
Less human touch
What Is Self-Directed Investing?
Self-directed investing is when you manage your own investment portfolio. You choose your investments, whether stocks, bonds, mutual funds, or other assets, based on your own research and risk tolerance. It’s a more hands-on approach, offering maximum control over your investments.
The advent of the internet and online brokerages has made self-directed investing quite accessible. Online brokers provide a wealth of tools and resources to support individual investors, from research reports and market data to educational content and advanced trading features. With these at your fingertips, you can make informed decisions about where to allocate your money.
However, while these resources can aid your investment decisions, they cannot replace the fundamental need for financial literacy and understanding of market dynamics. It’s essential to educate yourself about different asset classes, market trends, and investment principles.
At its core, self-directed investing is about taking ownership of your financial future. It allows you to steer your investments according to your own vision, whether that involves aggressive growth strategies, conservative income generation, or anything in between. However, with this freedom comes the responsibility of managing risk and making informed decisions. It requires time, effort, and a certain level of financial knowledge to be done effectively. It’s not for everyone, but for those willing to put in the work, self-directed investing can offer a sense of control and the potential for personal satisfaction that’s hard to match.
Advantages and Disadvantages of Self-Directed Investing
Self-directed investing offers the potential for greater returns, as you have the freedom to pursue your own investment strategies. However, it also requires a significant time investment for research and management, as well as a solid understanding of the financial markets. Therefore, the risks are also higher, as the responsibility for investment decisions rests solely on you.
Self-Directed Investing Pros & Cons
Pros
Flexibility and autonomy
Potential for superior returns
Low cost
Cons
Requires time, effort, and due diligence
Potential for inferior returns
Can result in overtrading or trades based on emotions
Robo-Advisor vs. Self-Directed Investing: Which Is Better for You?
There’s no one-size-fits-all answer to this question. If you value control, have a good grasp of investing, and are willing to put in the time, then self-directed investing may be a good fit. If you prefer a hands-off approach or are just starting out, then a robo-advisor could be a better choice. It ultimately comes down to your personal preferences, investment goals, and lifestyle. For example, the best robo-advisors offer specialized services like tax-loss harvesting, which may be important for some investors.
Indeed, the choice between a robo-advisor and self-directed investing is personal. It’s about finding a balance between control and convenience, risk and reward, and involvement and simplicity. By understanding your own investment style, financial goals, and lifestyle, you can make an informed decision about which approach is the best fit for you. Remember, the goal is not just to choose a method, but to choose the one that will best help you achieve your financial goals.
Should I Use a Robo-Advisor or Do It Myself?
It depends on your investment knowledge, time availability, and personal preferences. Both have their own strengths and weaknesses.
Robo-advisors can offer low-cost, diversified, and automated portfolios that are suitable for beginners or busy investors who want to save time and hassle. Doing it yourself can give you more control, flexibility, and customization over your investments, but it also requires more research, monitoring, and discipline.
You should consider your goals, risk tolerance, and investment style before choosing between a robo-advisor or doing it yourself through an online broker.
What Are the Disadvantages of Using a Robo-Advisor?
Limited investment options, lack of flexibility, and fees are the main drawbacks of robo-advisors. Robo-advisors typically invest in exchange-traded funds (ETFs) or index funds that track the performance of a market or a sector. This means that you may not be able to invest in individual stocks, bonds, or alternative assets that you are interested in. Moreover, robo-advisors charge an annual fee based on a percentage of your assets under management (AUM), which can add up over time and reduce your returns. Robo-advisors also often lack the human touch that some clients desire.
How Expensive Are Robo-Advisor Fees?
Robo-advisor fees vary by platform, but are generally lower than traditional human advisors. They usually charge a percentage of the assets they manage, ranging from 0% to 0.5% per year, with the typical fee being 0.25% per year of managed assets. Some robo-advisors may also offer premium plans that include access to human advisors or more advanced features, but they charge higher fees, such as 0.4% for Betterment Premium compared to its usual 0.25%.
How Many People Use a Robo-Advisor?
In the United States, 3.5 million investors used a robo-advisor to handle their portfolio in 2021, which was up 23.2% from 2020. The growth rate is expected to stay in the double digits for another two years, putting usage on pace to surpass 5 million adults by 2025. According to a survey of nearly 1,600 Americans, 63% of consumers are open to using a robo-advisor to manage their investments.Millennials are the most open to using a robo-advisor, with 75% saying as much.
The Bottom Line
Whether you choose a robo-advisor or self-directed investing, the most important thing is that your chosen approach aligns with your financial goals, investment knowledge, and lifestyle. Both offer unique advantages, and understanding these can help you make an informed decision about which path to take in your investment journey.
