Robo advisors: The next big thing in investing

robo advisor investing

You no longer have to be in the 1% to get sophisticated financial advice.

Technology is enabling people to make smart decisions about what to do with their money -- for a very low fee.

One of the biggest shakeups in the investment world is the introduction of "robo advisors." These are automated investment services that manage your stocks and bonds for you.

It's like "set it and forget it" for your portfolio. The computer program automatically adjusts your investments and even tries to minimize your tax bill.

"Great investing is a marathon, not a sprint. We're not set up to do every little thing every day for decades until we retire. Computers were built for it," Adam Nash, CEO of leading automated service Wealthfront, recently told CNNMoney.

So how do robo advisors work? Customers fill out an online questionnaire about their income, goals and comfort with risk taking. Computer software then selects the best investments, often in various low-cost exchange-traded funds (ETFs). Technology then does all the work, continually rebalancing the portfolios.

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The idea of computers controlling your portfolio may sound farfetched to some, but it's likely to catch on.

A robo boom: Millennials, who often don't have enough money to qualify for traditional advisors, are big users of robo advisors. They get an end result that is somewhat comparable to what a traditional advisor would do for them, but at a fraction of the cost.

"Robo-advisory services will become mainstream over the next three to five years," consulting firm A.T. Kearney concluded in a report published this week.

By 2020, robo advisors will manage about $2 trillion in the U.S., the report predicted. To put that another way, A.T. Kearney believes robo advisors will control 5.6% of Americans' investment assets by 2020, up from just 0.5% today.

Wealthfront is the leader in this rapidly-growing space, but there are many other major players, including Betterment, FutureAdvisor and WiseBanyan. Even Charles Schwab (SCHW) got into the act by launching its Intelligent Portfolios platform earlier this year.

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Millennials are big fans: As you might have guessed, robo advisors naturally appeal to younger investors. Wealthfront said 90% of its 30,000 clients are under the age of 50 and 60% are under 35.

That makes sense because many Millennials haven't accumulated enough wealth to meet the minimums of traditional advisers. Wealthfront's minimum is only $5,000 and it's free for portfolios of less than $10,000 in assets. After that it's only 0.25% per year.

Some robo advisors like Betterment don't even have a minimum, though accounts under $10,000 get charged a 0.35% fee. Betterment charges 0.25% up to $100,000 and then 0.15% after that.

"I know it's fashionable these days to be very negative about this generation. But if we take care of someone just starting out, they'll remember us when they are successful later on," said Nash.

Millennials are also an obvious group to target due to their skepticism about beating the stock market. People in their 20s and 30s lived through the dot-com bust and Great Recession that caused their parents' wealth to plunge.

"They're incredibly cynical about the idea there is this easy way" to make money in the market, said Nash.

Related: Millennials love these 10 ETF funds

Are robo advisors too simple? Of course, there are questions being raised about this approach to investing.

While robo advisors "sound fancy," they are basically just a "one-size-fits-all solution," Jeffrey Gundlach, the billionaire CEO of DoubleLine Capital, told a crowd at the Milken Global Conference in April.

His comments touch on a common critique that this passive approach to investing may not work for older investors with complex financial needs.

Yet Nash said such criticism fails to recognize the level of personalization provided by robo advisors.

For example, most robo advisors now deploy tax-loss harvesting tools. This technique is aimed at cutting your tax bill by selling securities at a loss to offset future capital gains taxes. Basically, it softens the blow of a losing stock while minimizing the tax hit on a winning stock.

Wealthfront says it is the only robo adviser to provide tax-optimized direct indexing for customers with over $100,000. Instead of buying a single ETF, the platform will purchase up to 1,001 individual securities in an effort to create more tax-loss harvesting opportunities.

"For humans this is a very boring thing to do. But computers don't get bored. They just run the numbers and do it everyday," said Nash.

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