Robo-advisors: A beginner’s guide
October 25, 2022 6 min read
Do you want to invest but aren’t sure where to start? Trying to figure out how to invest your money could feel overwhelming. And constantly monitoring the ups and downs of the stock market may not be realistic for everyone.
That’s why some people are turning to robo-advisors for their investing needs. These automated advisors might take the guesswork out of investing for those who don’t want to manage their portfolios alone.
Read on to learn more about robo-advisors and how they work.
- Robo-advisors are automated investment platforms that offer financial services with limited human involvement.
- Robo-advisors generally use a survey to determine a client’s goals, current financial situation and risk tolerance. This information is then used to develop an investment strategy.
- Robo-advisors typically charge lower fees than human financial advisors do, but robo-advisors may not offer the same level of personalized advice.
- Robo-advisor services use algorithms to provide ongoing portfolio management and rebalance clients’ investments as needed.
What is a robo-advisor?
Robo-advisors were first launched in 2008 as a less-expensive, convenient alternative to professional financial advisors. Today, there are many robo-advisor platforms to choose from, including those offered by large financial institutions.
Robo-advisors are digital financial advisors that automate the investment process. These platforms could offer many of the same services and benefits as human financial advisors, but for a fraction of the cost. That’s one reason robo-advisors are becoming a popular alternative for some investors.
In a sense, robo-advisors allow clients to put their investments on autopilot. These services typically use an online survey to learn about a client’s risk tolerance, financial goals, current assets and more. Robo-advisors use this information to create an investment strategy tailored to the client’s current financial situation and future goals.
These platforms generally use algorithms to automate and adjust investment strategies according to the ups and downs of the stock market.
How do robo-advisors work?
Each robo-advisor platform may offer different features and take a slightly different approach to investing. But potential clients typically need to create a profile and complete an online survey to get started. You may be asked questions about your investment goals, lifestyle and risk tolerance.
Be aware: There’s no such thing as a risk-free investment. Market volatility, inflation and asset liquidity could all affect a portfolio’s value. Be realistic about investment risks and your tolerance for them. And make sure you communicate this information to any advisor you’re considering.
Once you share this information, the robo-advisor will likely then suggest an investment strategy and portfolio based on your answers. Some platforms may choose from pre-created portfolios, while others could let you personalize part of the portfolio with specific types of investments, such as mutual funds.
Robo-advisors may use algorithms and a client’s data to automatically rebalance a portfolio by buying and selling investments according to the client’s risk tolerance and financial goals.
For example, a robo-advisor service might use an investment approach designed to limit risks while maximizing returns through diversified investing.
How much do robo-advisors cost?
Basic robo-advisor management fees typically range from 0.25% to 0.5% of a portfolio’s value.
For example, if you invest $20,000, you could pay anywhere from $50 to $100 in fees, but exact charges can vary by lender. Also, some platforms offer different plans, and you may have to pay more for a plan with extra features or benefits.
Comparing robo-advisor firms
Since the first robo-advisor platforms, Betterment and Wealthfront, launched in 2008, the fintech industry has grown quite a bit. Now there are dozens of platforms that investors can choose from.
When you compare robo-advisor firms, there are a few things you’ll likely want to keep in mind.
Price can play an important role in investment decisions, but it probably shouldn’t be the only factor. It’s also helpful to review the investment services offered by different robo-advisor firms.
Some platforms may offer services like automatic portfolio rebalancing and asset allocation that takes the client’s risk tolerance and goals into account. Tax-loss harvesting—or writing off investment losses to claim a tax deduction—is another service that some robo-advisors may offer.
Many robo-advisors build portfolios with exchange-traded funds—commonly called ETFs. An ETF allows investors to pool their money into groups of securities that can be bought or sold through a brokerage on the stock exchange. This type of fund may include bonds, stocks and more.
Since asset allocation can vary from one lender to the next, it’s helpful to review the number of asset classes a specific robo-advisor includes in its clients’ portfolios. For example, a robo-advisor that allocates a higher amount of assets to cash could create a more liquid portfolio for a risk-averse investor.
Be aware that ETFs charge an annual expense ratio based on the amount that’s invested in a specific fund. These fees typically range from 0.05% to 0.35%, and you’ll likely have to pay them regardless of the robo-advisor you choose.
Before you select a service, it’s helpful to decide what you want the investor-advisor relationship to look like. Are you comfortable working with a fully automated service? Or do you want a platform that offers some human guidance? You could also search the U.S. Securities and Exchange Commission (SEC) database to find firms and individuals who are registered with SEC regulators.
Each robo-advisor firm may have a different account minimum, which is the amount of money required to open an account. If you’re new to the world of investing, finding a robo-advisor with a $0 minimum may be helpful.
Robo-advisors vs. traditional financial advisors
When you explore your financial advisor options, it’s important to compare the differences between robo-advisors and traditional financial advisors. Both have potential advantages, depending on your financial situation and preferred manner of investing. And remember, there’s always a risk of losing money when it comes to investing.
Here are a few other factors you may want to take into account.
Robo-advisors use online surveys and algorithms to develop and manage investment portfolios. Here are some possible advantages of robo-advisors:
- They may have lower account minimums.
- They’re typically cheaper than human advisors.
- You could get real-time updates.
- This type of advisor could be a good choice for someone looking for a hands-off, simple investment strategy.
While robo-advisors may offer lower-cost, low-maintenance ways to invest, this may not be the best fit for everyone’s financial situation.
Traditional financial advisor
For some, a traditional financial advisor may offer some advantages:
- Traditional advisors can juggle different investment accounts and goals.
- This option could be ideal for those looking to invest a large amount of money.
- They can create personalized plans that take all of your goals and assets into account.
- You can ask questions and get personalized help with money management and your investments.
Keep in mind that you don’t necessarily have to choose between robo-advisors and traditional financial advisors. In fact, you may want to use both to reach your financial goals. You might consider working with a financial advisor for specific financial goals—like saving for college or planning for retirement. And you could use a robo-advisor for your other investment needs.
Robo-advisor pros and cons
When you’re searching for a robo-advisor service, it’s helpful to consider some potential pros and cons.
- Easy to invest: You can create and fund your account online. Some robo-advisors also have low or no minimum account requirements.
- Lower fees: Lower management fees could save you money.
- Semi-customizable: Robo-advisors tailor investment suggestions to your personal goals and preferences based on your online survey answers.
- Limited human support: Robo-advisors may have representatives to assist with technical issues, but some services don’t offer any support from human financial advisors.
- Doesn’t consider the full picture: Robo-advisors might not offer the same level of personalized advice that you’d receive from a financial advisor who reviews all your accounts, life plans and goals. Robo-advisors solely focus on investments, while financial advisors may also offer estate and tax planning advice.
- Can’t choose specific investments: Some robo-advisors could let you customize parts of your portfolio, but you generally can’t pick and choose individual investments.
Robo-advisors in a nutshell
Digital services, like robo-advisors, could make it easier to invest and take steps to reach your financial goals. But some people may be hesitant to trust their investments to online platforms. For others, though, a robo-advisor could be a helpful way to start investing. That’s because robo-advisors might be less expensive and easier to use than human financial advisors.
Keep in mind: All investments carry some level of risk. That’s why it’s a good idea to compare platforms, services and fees to find the advisor option that’s right for you. You can read more about investing strategies that could help you plan for long-term goals, like how to save for retirement.