Technology has automated many things in our society – even things once thought impossible to automate. Online banking, for instance, is now standard; instead of having to visit a bank teller you can deposit, transfer, and even apply for a loan right from a computer or smartphone. Now even your individual retirement accounts, or IRAs, can be managed automatically by a robo-advisor – but is it a good idea? First, let’s take a quick look at what IRAs and robo-advisors are.
What’s an IRA?
An IRA is a type of retirement account at a bank or other financial institution that allows you to save for retirement by investing. There are three basic types of IRAs, and each of them have a specific tax benefit.
- Traditional IRA: With a traditional IRA, you make pre-tax deposits to the account (called contributions) and the money grows without being taxed until you withdraw it after retirement.
- Roth IRA: With a Roth IRA, you make the contributions out of money you’ve already paid taxes on, and you can avoid paying any further taxes on the money, even when you withdraw it.
- Rollover IRA: If you leave an employer where you’ve been contributing to a 401(k) or 403(b) retirement plan, you can “roll over” the account into a traditional IRA.
Now that we’ve talked a bit about IRAs, let’s take a look at robo-advisors.
What’s a Robo-Advisor?
A robo-advisor sounds like it’s a robot, and that’s kind of what it is – an automated portfolio management tool that uses computer algorithms and other tools to manage your money. They can be used for many types of investment accounts including IRAs.
Traditionally, your options for managing your IRA were slim. Either you did it yourself – and hoped you picked the right investments for solid, steady growth – or you paid fees to a financial advisor or firm to manage it for you. In many cases, you’d have to not only have a sizeable initial investment – in some cases hundreds of thousands of dollars – but you paid annual fees to the financial advisor or their firm as well, usually a percentage of the balance or earnings over the year. That meant you also had to do well in your investments, or you’d still end up losing money.
With a robo-advisor, you can set up your own retirement accounts and have the computerized advisor manage them based on the parameters you’ve set, such as your personal risk tolerance and type of investments you’d prefer to put your money into. Some robo-advisor companies even offer access to human managers via in-app text messaging, so if you have a quick question you can still get the answers you need without the bigger expense associated with using a regular investment firm.
Should I Use a Robo-Advisor for my IRA?
The short answer is yes, if you’re largely a hands-off investor who wants to make contributions while leaving the portfolio building and management to someone – or something – else. There are a number of robo-advisor firms and options available, depending on the type of investor you are and what you’re looking to do with your money. They use something called modern portfolio theory, which basically automates finding stocks, mutual funds, index funds, or ETF’s that won’t swing wildly in value, but will provide a decent, steady return. In other words, with a robo-advisor you won’t get rich in a few days or weeks, but you should see constant, slow growth over time.
Charles Schwab and WiseBanyan both offer robo-advising with no management fees and low or even zero minimum investments, a great choice for those who are starting off slowly. Wealthsimple and Betterment offer relatively small management fees, but still have no minimum balances, and Betterment currently has a promotion that waives those fees for up to the first year. Wealthfront, considered one of the best robo-advisor firms, has a $500 minimum account balance but will manage the first $15,000 in your account free. Fidelity Go is considered one of the best-robo advisors specifically for IRAs.
It might be a bit frightening to trust your money to an algorithm, but robo-advisors are based upon Nobel Prize-winning theory and solid technology. If the idea of trying to manage an investment portfolio sounds too complex or too expensive, try a robo-advisor; you might find that investing is much easier when you let a “robot” do it for you.