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Investing Apps Can Foil Financial Planning

New investors need at least two things: money and confidence. But many beginners, especially younger people, lack both.

What they do have are investing apps, carefully designed to plug those holes by removing minimum investment requirements and adding a little encouragement. One company, Acorns, will literally invest your small change.

These apps bring what has historically been a rich person’s game to the masses — fund companies, brokerages and financial advisory firms have long locked out small-dollar investors. The problem: Many people may not be ready to invest, and if they are, an investing app alone isn’t the best place to do it.

Ignoring the financial big picture

Advisors frequently compare financial planning to building a house: First, you lay the foundation — an emergency fund, insurance coverage and a balance sheet free of high-interest debt. An app can upend that, says financial technology expert Bill Winterberg.

“For these apps, the answer to the question of ‘what should I do with my money,’ 100% of the time, is that you should invest. An advisor, on the other hand, says, ‘Should you pay down debt? Do you need more insurance coverage? Do you have enough money in an emergency fund?’” Winterberg says. “Those might be really good ways to use extra money.”

Acorns, which rounds up dollar amounts from users’ everyday purchases and invests that change in a managed portfolio, says its technology reframes this issue. By focusing on extra pennies, investing “can happen alongside traditional financial building blocks,” says Heather Gordon, the app’s brand manager.

The scenario Gordon describes is the best way to use these apps; investing rounded-up change or another small amount is innocuous and even helpful as an educational exercise. But Acorns says over half of its users make recurring investments beyond the rounded-up amounts. Other apps, like Robinhood, which offers free stock trading, and Stash, which serves educational content to help users build a portfolio of exchange-traded funds, accept only traditional lump-sum deposits.

Erica Bentley, content manager for Stash, says the service isn’t trying to answer all financial needs. “It would be great if [users] started with paying off debt, or having an emergency savings account built up, but for a lot of people Stash is the first entrance into thinking about saving, and with our content, they learn they should also be considering an emergency savings account.” The question is whether a service like Stash is well-suited to being that first entrance.

Shortchanging retirement accounts

Much as in financial planning, there’s a widely recommended order for how to invest your dollars: Tax-advantaged options, like 401(k)s and individual retirement accounts, come first.

The paradox is that as investing apps target young, beginner investors, many offer only taxable brokerage accounts, directing dollars away from the tax-free or tax-deferred growth of traditional and Roth IRAs.

“If they’re directing these investors to a traditional brokerage account, it doesn’t have those tax advantages, and over time, that could compound to tens of thousands of dollars — potentially hundreds of thousands of dollars if we have a bull market,” says Winterberg.

Acorns and Stash both plan on adding retirement accounts in the next year.

Understanding the risks

Apps typically use a questionnaire to identify an investor’s goals, time horizon and appetite for risk. But “even the process of asking people about their risk tolerance doesn’t have much follow-up to verify that the person — who may be new to investing — really understood the questions, and the risks involved,” says Michael Kitces, director of wealth management at Pinnacle Advisory Group.

Robinhood adds additional risk with “Robinhood Gold,” a fun name for margin trading, or the ability to buy stocks on borrowed money. Robinhood says the service, which charges a flat fee, is reserved for “experienced investors” — federal regulations require a $2,000 account minimum — but the app is bare-bones and provides little education about the risks besides a disclosure and an FAQ. In this kind of trading you can lose more than you’ve deposited.

Margin trading is offered by many brokers, who frequently charge interest rather than Robinhood’s more user-friendly fee. Robinhood says its app is used by many investors as an “educational experience” — but engaging in margin trading could quickly make it a costly one.

Fees drag down small portfolios

Finally, there are the fees. Robinhood offers free trading if users avoid the aforementioned margin activity, and Acorns is free for college students. Otherwise, Acorns and Stash have the same fee structure: $1 a month for accounts under $5,000, and 0.25% per year for accounts of $5,000 or more.

Neither service communicates that flat fee to users as a percentage of assets — which is how most investments are priced — but when sliced that way, $1 a month is 2.4% a year on $500, much more than a financial advisor would charge.

The argument from these apps is that most financial advisors and even online brokers won’t handle an investment as small as $500. Even if a broker has no deposit requirement, mutual fund minimums are rarely under $1,000. And that may be by design.

“People who don’t have $1,000 to invest are people who don’t have $1,000 to invest, and there’s a reason for that,” says Winterberg. “They may be spending more than they earn, or they may have credit card debt. Perhaps investing isn’t the right choice for them right now.”

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Arielle O’Shea is a staff writer at NerdWallet, a personal finance website. Email: aoshea@nerdwallet.com. Twitter: @arioshea.

This article was written by NerdWallet and was originally published by USA Today.

The article Investing Apps Can Foil Financial Planning originally appeared on NerdWallet.