Is Your Robot Advisor Really Helping You Save Money for Retirement?
Robo Advisors make investing super easy and even better, they are fun! However, just because you are investing with the app does not mean that you are investing correctly.
A friend recently told me that she was using an investment app. “Oh, are you saving up for retirement with one of those robo-consultants?” I have asked. “Probably?” she said, not knowing if she had a retirement account. It turned out she didn’t, and the app she was using was just opening a regular, taxable investment account .
The main reason to start investing is to save for the future, namely retirement. And there are special retirement accounts like 401 (k) or Individual Retirement Account (IRA). These accounts have special tax advantages that make them ideal for long term investment .
For example, with most 401 (k) s and traditional IRAs, you can usually deduct the amount saved from taxable income, thereby reducing your tax bill for the year. With a Roth IRA, the money you make in an account grows tax-free, which means you never have to pay taxes on that income.
These are quite large tax advantages, which is why experts recommend giving preference to retirement savings over regular taxable investment accounts, which offer no real tax incentive to save. Ramit Sethi calls this the “ladder method .” It works like this:
- Step 1 : Take full advantage of your employer’s 401 (k) compliance, if offered. This is free money.
- Stage 2 : Pay off your credit card and other debts. Your annual interest rate is likely high, and getting rid of that burden is “significant instant payoff,” Sethi says.
- Stage 3 : Open the Roth IRA and deposit as much as possible into it. Read our beginner’s guide to IRA to learn more about Roths.
- Stage 4 : If you have exhausted your IRA and you still have money to invest, then invest more in 401 (k).
- Step 5: Is there still money to invest after it’s depleted? Open a regular account without retirement security and deposit it there.
You should only open a taxable investment account after you reach the fifth pillar. But many people don’t know this. They view robot consultants as a one-stop investment solution and think:
“Oh, cool! Now I’m investing. I’m a responsible adult!”
Many people fail to realize that even though they are technically investing, they are not prioritizing their savings as they should.
None of this is intended to knock out apps like Acorns that allow you to invest extra little change or start investing with very little money. The point is, if you are going to use a robo-consultant, make sure you know what kind of investment account you are dealing with.
Apps like Acorns make investing easy and fun, but they’re not meant to replace savings for retirement. However, some robo consultants are into retirement planning and you can use a tool like NerdWallet for comparison and research. Better yet, if you’re looking to start saving for retirement, read our complete guide to make sure you know what you’re getting into.