The term “robo advisor” may conjure up images of a robot sitting at a computer picking stocks, but that science fiction scene isn’t the reality for the industry. With a robo advisor, your money is invested in a professionally-managed portfolio that is optimized for your investment goals. Keep reading to learn more about what robo advisors are, how robo advisors work, and whether a robo advisor makes sense for you.
In this Guide:
What is a Robo Advisor?
There are many definitions of what exactly robo advisor is. To put it simply, a robo advisor is a method of automating the asset allocation of investments via a computer algorithm.
In a broader sense, a robo advisor may also include human financial advisors but only for services that require human assistance (e.g., taxes, retirement, or estate planning).
Overall, the Investor Junkie team considers the rise of and interest in robo investing services a good thing, pushing down the costs of high-fee Wall Street advisors who offered little real value while dragging down returns. This is positive for consumers in any competitive marketplace.
Robo advisors help individuals who typically have no clue where to begin when choosing investments. As with almost everything, one size does not fit all when it comes to financial advice. However, this space fills the need of most beginner investors and even experienced investors who prefer a more hands-off approach.
Understanding How Robo Advisors Work
Behind the scenes, robo advisors are managed by investment professionals who work similarly to traditional financial advisors. Instead of serving one customer at a time, the robo and human advisors work together to serve thousands of customers at once.
When you sign up for a robo advisor, you’ll answer a survey with questions about:
- Your age
- Your Investment goals
- Risk tolerance
- Other nuances
Based on those answers, you are assigned a portfolio weighted to your investment goals. Because there are likely many other people with similar goals, you may have the same portfolio as others. But as long as you get good performance at low costs, that’s no problem.
Here are some key robo advisor features to understand:
- Human-designed portfolios: Portfolios are designed by teams of professional investors and computer engineers to give customers a semi-personalized portfolio aligned with their investment goals.
- Fees are typically lower than traditional advisors: Human advisors often charge a 1% fee or more. With a robo advisor, you’ll generally pay less and some robo advisors don’t charge any additional management fees.
- You'll have some control over your investments: Some robo advisors give you the option to update your answers or tweak your portfolio.
- Robo advisors may have advanced features: Depending on the service you choose, you may have access to advanced features like automated tax-loss harvesting, automatic rebalancing, different allocations for multiple goals, and other features to improve your financial performance.
Automatic Portfolio Rebalancing
One useful feature that’s very common among robo advisors is automatic portfolio rebalancing. This is an important part of investment management as portfolios often drift away from their target allocations due to varying investment performance over time.
When your portfolio is rebalanced, some investments are sold and others are purchased to bring your portfolio back to its ideal alignment. Human advisors can do this as well, though it typically happens less frequently. When you use a robo advisor, rebalancing occurs on a schedule or with the click of a button.
What To Consider When Hiring a Robo Advisor
When choosing a robo advisor, the most important factors will vary based on your goals. Here are some common criteria to consider when picking a robo advisor:
- Accounts supported: If you want a specific type of retirement account, it’s important to pick a robo advisor that supports that type of account. Some advisors offer just one or a few accounts, while others offer more broad support for taxable, retirement, custodial and other needs.
- Costs and fees: One of the biggest draws to robo advising is the low cost. However, every advisor has its own pricing model. Shop around to find the right deal for your goals. A slightly higher fee can easily add up to many thousands of dollars over years of investing.
- Investment portfolios: Some robo advisors have just a few pre-designed portfolios. Others customize your portfolio weighting or offer special portfolios for sustainability and other investment priorities.
- Advanced features: Depending on your goals, tax-loss harvesting, and other advanced features may be a draw. If you’re deciding between two or three favorites, this may be a good tie-breaker.
Find out more about the robo advisors we recommend on our Best Robo Advisors page.
How Much Should a Robo Advisor Cost?
Robo advisors charge in two ways. First, you’ll pay a management fee, if one applies. Second, you’ll likely be charged fees by the funds your robo advisor chooses for you. Here’s how to assess those fees:
The first fund to look for is the management fee. This is a fixed fee that robo advisors charge for choosing your investments and other services they provide. Depending on the robo advisor you choose, you can expect to pay anywhere from 0% to around 0.50% per year based on your portfolio balance, though some charge more.
Even after you’ve paid your management fee, you’re still not done paying. Each fund that the robo advisor picks for you likely charges its own fee. While some exchange-traded funds (ETFs) may charge more, most robo advisors make a point of keeping client funds in low-fee funds.
Let’s say you invest $50,000 with a robo advisor that charges 0.25% annually. In your account, the average ETF fee is 0.7%. Here’s how much you would pay:
- Management fees: $50,000 x 0.25% = $125
- Fund fees: $50,000 x 0.07% = $35
- Total fees: $160
Even if you pick your own investments, you’ll likely have some ETFs or mutual funds that charge fees, so that 0.7% may be unavoidable either way. But the management fee charged by the robo advisor is the biggest chunk of the cost, so it’s important to shop around to avoid overpaying.
Is a Robo Advisor Right For You?
The answer to this question depends on your net worth, your investments' complexity, and whether you feel comfortable investing by yourself. I believe that robo advisors add value and that you can't easily replicate their results by using Fidelity or Vanguard funds.
Most of my family assets are DIY, but I've also used robo advisors for a six-figure chunk. I feel very comfortable using and recommending robo advisors.
Are Robo Advisors Safe and Secure?
The online tools robo advisors offer aren't new. Traditional financial advisors had the same tools available to them for years and could roll up a personalized asset allocation plan. Robo advisors push the technology down to the masses. You have direct access to manage your account and it removes the non-value-added middlemen.
Some financial advisors can add tremendous value, however. They can offer guidance to the asset allocation best for you based upon unquantifiable factors, which computer programs can never do. But this is often more the exception than the rule.
Financial advisors can give recommendations about long-term life decisions (e.g., helping save for a child's education through a recommended action plan). Some robo advisors are just tech-assisted firms and not 100% automated. If you want it, the human element is not entirely removed from the loop at some firms, though you may have to pay extra for that perk.
Robo advisors, like other investment brokerages and advisors, are regulated by the SEC and FINRA. In most cases, your portfolio is protected by government-backed insurance as well.
There's something to be said for any 100% algorithm-driven investment approach. While it might help with a high percentage of individuals, there are always cases in which automated guidance isn't appropriate.
How Do Robo Advisors Make Money?
The main way robo advisors make money is through management fees. Also, some may make money by sending investment dollars to the company’s own family of funds. For example, the no-fee Schwab Intelligent Portfolios product uses low-fee Schwab ETFs, which do charge fees.
It’s always important to understand how you’re charged so you can make the best decisions for your money.
Pros and Cons of Investing With Robo Advisors
- Little investment knowledge required
- Very low time commitment
- Low costs and fees
- Portfolios align with your investment goals
- May not have access to a human for help
- Human-provided services may require an extra fee
- May have little or no say in what funds your money is invested in
Final Thoughts on Robo Advisors
There’s no reason for modern investors to shy away from robo advising. These are tested and trustworthy investment tools that make the stock market accessible to anyone at a meager cost. If you’ve been putting off investing or considering going the robo advising route, this type of investment advisor may be perfect for you.