by Jack Waymire
A Robo Advisor and Online Financial Advisor (OFA) are the same type of service provider. They both provide online investment advisory services. You do not meet face-to-face with these online financial advisors when you use their services.
I prefer Online Financial Advisor because it is a better description of the services that are provided by this new type of financial advisory firm. All of the services are delivered online and they act as financial advisors, not as money managers.
Advisors vs Managers
There are financial advisors and there are money managers. Mutual funds are a type of pooled money management because they select securities and make the buy/sell decisions. There are also separate account managers that do not pool assets for investment. They also select securities and make buy/sell decisions.
Financial advisors do not make investment decisions. One of their most valuable services is recommending the money managers who do make the investment decisions. For example, an Online Financial Advisor selects the ETFs for your portfolio. The ETFs are the money managers because they select the securities.
Exchange Traded Funds (ETFs)
ETFs are index funds that trade like securities. This makes it easy, efficient, and cheap to buy and sell ETFs on the exchanges. For example, there is an S&P 500 index that represents the performance of 500 U.S. stocks. You can invest in the index by buying a mutual fund (index fund) or an ETF.
ETFs are designed to capture the performance of particular asset classes. The S&P 500 captures the performance of 500 large capitalization U.S. stocks. There is an ETF for just about every asset class that is available for investment.
Cookie Cutter Portfolios
You provide the Online Financial Advisor with information about your situation and the OFA uses the information to plug you into a cookie cutter portfolio of ETFs. Although cookie cutter may sound bad that is exactly what mutual funds have done since their inception. For example, you pick a fund based on your performance expectations and tolerance for risk and it delivers the same services to you that is delivered to thousands of other investors who share your criteria.
Passive vs Active Management
ETFs are designed to match the market performance of particular asset classes. Their performance should be within a few basis points (100 basis points = 1%) of the index. This is called a passive process because money managers are not picking securities. They buy indexes of securities.
The financial advisor may also use passive asset allocation, for example you invest 25% of your assets in a Large Capitalization Value ETF and you do not change the allocation except for rebalancing and tax loss harvesting.
Your alternative is active management that uses ongoing asset allocation and stock or fund selection decisions to produce superior returns. You will pay higher fees for active management that is supposed to deliver better results than passive alternatives.
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