by Jack Waymire
With all of the recent buzz happening in the online financial advice space, we thought it would be appropriate to review our terminology that we used in our first story, below. In our story, we used the term Online Financial Advisor (OFA) to describe web-based companies that provide 100% automated investing solutions to investors.
The term Online Financial Advisor was met with some resistance among those in the financial services profession because many financial professionals offer planning and other services to clients in an online environment, so this confused the matter that much more. What we’ve learned is that there is no set naming convention used yet to describe what many are now calling Robo-Advisors. For purposes of this article, feel free to replace the term Online Financial Advisor with Robo-Advisor which may help in an effort to clarify the various levels of service and choices that investors have today.
We know computer programs can produce cheaper investment performance, but can they produce better investment performance. This is a new choice for investors. You can select a Robo-Advisor to manage your assets using algorithms or you can select a Financial Advisor who will provide tailored solutions and meet with you face-to-face. The advisor can also deliver planning advice and services which is usually precursor to investing your assets in the securities markets.
You have a new alternative for the investment of your assets. You can select an Online Financial Advisor (OFA) or a Personal Financial Advisor (PFA). You should know the key differences before you make your selection decision.
Is an Online Financial Advisor a Mutual Fund?
Your assets are pooled with other investors when you invest in a mutual fund. You own the same investments as everyone else in the pool and you receive the same performance as all of the other investors.
An Online Financial Advisor (OFA) does not have registrations that permit them to pool investor assets. Instead, they have cookie cutter portfolios of Exchange Traded Funds (ETFs) that treat all investors the same. In this regard, an OFA portfolio is similar to a mutual fund.
A Personal Financial Advisor (PFA) meets with you to discuss your current circumstances, performance expectations, and risk tolerance. He will build a portfolio of securities, mutual funds, ETFs, and other investments that reflect your needs and requirements.
Paladin: OFAs invest in diversified portfolios of ETFs. PFAs can also invest in portfolios of ETFs. However, each PFA client can be different reflecting current market conditions and other considerations.
OFAs and some PFAs invest your assets in portfolios of ETFs. There is no significant difference. In fact, they could both be investing in the same ETFS. The expenses that are charged by the ETFs are the same for both parties and they do not include the fees that are charged by the OFAs and PFAs.
OFAs have low expenses because computers manage your assets. There is no direct involvement by investment professionals. PFAs have higher expenses that cover the costs of personal interaction.
For example, an OFA may charge a 15 to 35 basis points (100 basis points = 1%) fee for its computerized services. A PFA may charge 75 to 100 basis points for his personalized services.
Paladin: OFAs charge lower fees than PFAs. However, you have to be willing to give up any personal interaction with the advisory service provider to get the reduced fee.
Integrated Financial Services
If you are like most investors you need some combination of planning, investment, insurance, and tax services. You can obtain the services from one professional or multiple professionals.
Most OFAs offer an investment service and that’s it. You will have to obtain the remaining services from PFAs (planning), insurance professionals, and CPAs.
Paladin: Your best bet is a Personal Financial Advisor if you want integrated advice and services.
Another major distinguishing characteristic that differentiates OFAs from PFAs is your ability to talk to a real, live financial professional.
Some OFAs allow personal contact and some do not. The addition of professionals drives up their cost structures and a primary differentiating characteristic for OFAs is low expenses.
Paladin: The main advantage of a PFA is communications. You can meet with PFAs or pick-up the phone and talk to them.
Online Financial Advisor or Personal Financial Advisor?
You should consider an Online Financial Advisor if you are young, have a small amount of assets (<$100k), have a relatively simple financial situation, and you are comfortable letting computer programs manage your assets.
You should consider a Personal Financial Advisor if your personal situation is more complicated, you have a larger amount of assets, and you want personalized services from a professional you can meet with face-to-face.
Paladin: An Online Financial Advisor is your low cost solution, but what do you give-up to reduce your fees by 50 to 80 basis points? You give-up integrated solutions (financial planning, insurance advice, or tax advice), personalized portfolios, and the ability to have direct contact with a Personal Financial Advisor who knows you, your concerns, your requirements, and your expectations.
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