A robo-advisor is an automated tool that provides financial advice and services. It uses computer algorithms to automate investing based on your personal goals and risk tolerance and build and manage your investment portfolio.
Robo-advisors make investment advice more accessible to more people, creating a more level playing field. This is because they usually charge lower fees and have lower minimum balances than traditional investment services.
With robo-advisory services, investment is more accessible to the average consumer who doesn’t have the time to monitor and rebalance their portfolios, not to mention those who lack the thousands of dollars needed to invest with certain traditional brokerage firms.
How Do Robo-Advisors Work?
Robo-advisors provide a digital platform that manages your investments automatically. You can access the platform 24/7 from your phone, tablet or computer.
Some of the tasks that a robo-advisor can do include:
- Automatic rebalancing
- Tax-loss harvesting
- Retirement planning
- Investment selection
While all robo-advisors tend to follow a similar pattern of operations, each robo-advisor is different. Upon signing up for a robo-advisor, you’ll likely have to complete a questionnaire that includes your general information and financial needs.
Here is some of the information you’ll probably need to provide:
- Full name
- Birthday
- Retirement status (working or retired)
- Current tax filing information
- Retirement accounts you’re already contributing to
- Estimated household spending
- Financial goals (for example, saving for a house, retirement, a vehicle or other large expenses)
Determining Risk Tolerance and Building a Portfolio
The robo-advisor must also determine your risk tolerance to choose the best investments for you. It will likely do this by getting your reaction to different scenarios to assess your risk versus reward preferences.
The algorithm will then build a portfolio based on your answers. Some robo-advisors may offer just one option based on the ETFs (exchange-traded funds) or index funds the company has to work with. Others may have a selection of portfolios you can choose from based on risk tolerance, investing preferences or social concerns like ESG (environmental, social and governance) funds.
Robo-advisors typically use passive investing strategies. That means you don’t get to choose the index funds and ETFs in the portfolio. The computer picks them according to modern portfolio theory (MPT). It’s a way of selecting investments to maximize their overall returns, balanced with an acceptable level of risk.
This technique can be a great way to help you keep a diversified portfolio, meaning a mix of investment options, so that you don’t put all your money into one basket. If you’re new to investing, a robo-advisor can help ensure your money is diversified across multiple indexes, which can help protect you if the market goes down.
Remember: All investing carries risk. There is no guarantee that you’ll see a return on your money or even get your original amount back.
Once you’ve selected your portfolio, you’ll work with the robo-advisor company to complete the setup and transfer money to your account.
Robo-Advisors vs. Financial Advisors: What’s the Difference?
A robo-advisor is a computerized financial advisor that uses an algorithm to give you financial advice and provide financial services. A human financial advisor (just as you would guess) is a human trained and licensed to be a financial advisor.
Traditionally, only individuals with a certain amount of funds had access to the best financial advice. Robo-advisors change all of this by using algorithms to provide financial advice. This means that almost everyone can access a digital financial advisor.
Using a robo-advisor usually means lower fees and lower minimum balances than you would experience with traditional investment services.
Using Both a Human & Robo Financial Advisor
You can also combine the power of a robo-advisor with a human financial advisor by choosing a hybrid option. The human financial advisor can answer any questions and guide you in the right direction. You can expect to pay more for a hybrid option than you would for just a robo-advisor.
However, it is often more affordable than exclusively meeting with a traditional financial advisor in person. With a robo-advisor, you can automatically manage your investments. A benefit of using a robo-advisor (or a human financial advisor) is that it can help you feel better about where you’re putting your money and about saving for your future.
Pros and Cons of Robo-Advisors
When you’re choosing between a robo-advisor and a human financial advisor, it’s important to think of the pros and cons of robo-advisors. You’ll also need to remember that different robo-advisors vary in their features and costs.
With that in mind, let’s take a look at some general pros and cons of many robo-advisors.
Pros
- You can access the platform 24/7 from your phone, tablet or computer.
- It is more affordable to use a robo-advisor than to hire a human financial advisor.
- Robo-advisors are a convenient option for people who don’t have time to talk to a human financial advisor.
Cons
- You likely won’t get to choose your portfolio’s index funds and ETFs. The computer picks them according to modern portfolio theory.
- You may get less flexibility in your investment strategy.
- Not talking to a human financial advisor may mean you don’t learn about certain opportunities.
Understanding Robo-Advisor Fees
While the fees involved with a robo-advisor are much lower than what you would have to pay for a human financial advisor, there are still fees and minimum balance requirements. You’ll also likely have to pay an annual management fee, usually a flat monthly fee or a percentage of the assets managed by your advisor.
Typically, you can expect fees between 0.25% and 0.50% of your assets under management. With this fee structure, you can expect to pay between $25 and $50 per year if you have $10,000 invested through a robo-advisor.
Other fees to pay are those that the index funds or ETFs you invest in through your robo-advisor portfolio charge. These are also referred to as the fund’s expense ratios. In most cases, these probably won’t cost much, as most robo-advisors select low-cost funds.
Let’s take a look at some examples of robo-advisor fee structures:
- Vanguard’s Digital Advisor offers your first 90 days for free (you still pay investment costs). After that, the fees are generally $15 to $16 per year for every $10,000 in your portfolio (if it’s an all-index portfolio). You need at least $100 in assets to enroll in Vanguard Digital Advisor.
- SoFi Invest provides portfolio recommendations built by experts at SoFi and BlackRock. Using a robo-advisor here makes customization simple and easy so that you can meet your personal preferences and objectives. SoFi Invest also includes the opportunity to have virtual meetings with human financial planners without paying extra.
- Betterment lets you invest for a flat fee of just $4 per month if you have a balance between $0 and $20,000. However, if you set up recurring monthly deposits of $250 or have an account balance of at least $20,000, this will switch to an annual management fee.
Is a Robo-Advisor Right for Me?
If you’re not a hands-on investor and want a “set it and forget it” investing method, investing with a robo-advisor might be a good option.
A robo-advisor might be a good pick if you want to periodically check in on your portfolio without having to worry about tax-loss harvesting or rebalancing, which can take up a lot of your time.
Here are some other circumstances in which a robo-advisor might be suitable:
- You want a low-cost account managed by a professional investment firm.
- You want an easy and seamless experience when your portfolio is rebalanced or tax advantage solutions are sought.
- You want 24/7 online access to your account, but you want to avoid speaking with someone over the phone or via video chat.
- You feel comfortable with the robo-advisor (which is controlled by an investment company) making your investment decisions for you.
Robo-Advisors Are Useful Tools in Financial Services
If you want to save money on your financial advising fees and/or are too busy to spend a lot of time talking to a human financial planner, a robo-advisor may be a good choice for you. However, before you make a final decision, it’s crucial to learn about the characteristics and advantages of each. Use the information you’ve discovered here to help you on your financial journey. nd the fees, minimum balance requirements and investment options each company offers before investing.
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