What is a Robo-Advisor? Pros and Cons
Robo-advisors have stormed onto the investment scene as a way for all investors to participate in the wealth-building possibilities of the markets. Finally, get the answer – How do robo-advisors work?
No longer do you need deep pockets to hire a financial advisor or to invest in a professionally managed portfolio. From Betterment to Schwab or M1 Finance, the robo-advisory choices are vast. But, if you’re wondering What is a robo-advisor and how do they work? read on.
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*Disclosure: Please note that this article may contain affiliate links which means that – at zero cost to you – I might earn a commission if you sign up or buy through the affiliate link.
A robo-advisor is an investment manager that uses computer programs to professionally invest your money. Beyond that, there are many varieties of robo-advisors with diverse fees, investment minimums and features.
If you’re interested in a low-cost, professionally managed investment approach, then a robo-advisor might be for you.
*Disclosure: Please note that this article may contain affiliate links which means that – at zero cost to you – I might earn a commission if you sign up or buy through the affiliate link.
How a Robo-Advisor Works
Robo-advisor algorithms are at the center of the robo-advisor investment manager. In fact, synthesizing algorithms has been the backbone of successful programs in various fields. Waze and Uber are known for their transportation algorithms and Google for its search engine algorithms.
But, what is a robo-advisor algorithm – in plain English?
Here’s how an algorithm works.
An algorithm is a fancy word for the process that a computer uses to solve a problem. A robo-advisor’s computer algorithm is the steps the computer takes to create your investment portfolio. It’s kind of like a roadmap that the computer creates just for you – after integrating your responses to a few basic question.
For example, after you respond to questions about your age, goals, risk tolerance and current financial status, the robo-advisor computerized algorithm computes the best investment portfolio for you. The computer is taught or programmed to take your information and integrate it with important investment research to create a portfolio with the best returns at your given time line and risk level!
Computerized robo-advisor algorithms are perfect for investors due to their inherent efficiency and cost-effectiveness. And, picking investments based upon the best-practices investing research can actually be done better by a computer than a human.
Find out: M1 vs. Betterment – Which is the Best Robo-Advisor for Me?
At first glance, the robo-advisor concept might seem doubtful and risky. After all, traditional investment management was grounded in meeting with a financial advisor, coordinating with a stockbroker, or even becoming your own financial manager. In contrast, most robo-advisors were founded on Nobel Prize winner Harry Markowitz’s Modern Portfolio Theory, which explains how to create diversified investment portfolios with the greatest returns for each risk level.
So how do robo-advisors work? Robo-advisors are computerized financial advisors that excel in one thing: creating diversified investment portfolio following sound computer algorithms based on well-recognized modern portfolio management strategies.
Robo Advisor Pros and Cons
Pros
- Fees lower than traditional financial advisors
- After set up, requires minimal oversight
- Access to a variety of assets, depending upon the robo-advisor including crypto and alternatives
- Numerous varieties including robos with financial advisors, low fee, actively managed and more
Cons
- Minimal customization
- Customer service can be somewhat limited
Who Benefits from a Robo-Advisor?
Beginning investors – Those Just starting out and don’t know much about investing will benefit from a robo. And, if you don’t have much money, these robo-advisors have low investment minimums:
- SoFi Automated Investing – Zero minimum
- Betterment – Zero minimum, $10 to begin investing
- Ally Invest Cash Enhanced Managed Portfolios – $100 minimum
- M1 Finance – $100 minimum
- Acorns – Zero minimum
Investors seeking financial advisors – Many robo-advisors now offer access to financial advisors. Even small investors can get financial advisory help! These robo-advisors offer financial advisors:
- SoFi Automated investing
- Betterment (financial advisors for additional fee)
- Empower (formerly Personal Capital)
- Ellevest
Hybrid Robo Advisors with Financial Advisors
Investors who want a managed investment portfolio and the opportunity to trade investments – Many major investment firms offer robo-advisors plus a wealth of other investment and banking services. Several of our favorites include:
- M1 Finance
- Wealthfront
- Ally Invest Cash Enhanced Managed Portfolios
- Schwab Intelligent Portfolios
- Vanguard Personal Advisor Services and Digital Advisor
High net worth investors and retirees – You might be surprised to discover that even those with a lot of money may want low fee investment management. There are several robo-advisors specifically designed for these individuals including:
Best Robo Advisors For Wealthy Investors
How do Robo-advisors Work? The Details
The Questionnaire
These automated advisors ask you your age and a few questions about risk, goals and your time horizon. Then the platform runs your choices through their computerized robo-advisor algorithms. Next, you’re assigned a risk level ranging from conservative to aggressive.
Most robo-advisors divide their investment portfolios by risk. So, based upon your risk level, from conservative through aggressive, you’re provided with a collection of investments, in specific proportions, that meet your criteria.
The Investment Portfolio
The robo-advisor platform begins with a short questionnaire about financial goals, age and risk tolerance. Next, the robo advisor account creates a group of investments, or portfolio that incorporates your responses to the questionnaire. For example, a young, aggressive investor might receive a recommendation for 90% stock investments and 10% bonds. While a conservative or older investor might receive a portfolio recommendation with 60% bond ETFs and 40% stock ETFs.
Most platforms allow you to adjust the portfolio to make it more or less aggressive or conservative.
The Investment List
Robo-advisor investing incorporates many different types of investments along with various investment styles. The typical robo-advisor invests in a passive style using index funds in various mixes for distinct types of investors, from conservative to aggressive investors.
Other robo-advisors like Vanguard and Personal Capital tailor their robo-advisors to the client and add in various investment styles. Socially responsible robo-advisors are becoming more popular with more platforms including them in their asset mix.
Following are examples of the types of funds you might find in a typical robo-advisor:
| Sector | Ticker |
|---|---|
| U.S. Total Stock Market | VTI, SCHB, ITOT |
| U. S. Large-Cap Value | IVTV. SCHV, IVE |
| U.S. Mid-Cap Value | VOE, IWS, IJJ |
| U. S. Small-Cap Value | VBR, IWN, IJS |
| International -Developed Market | VEA, SCHF, IEFA |
| International - Emerging Market | VWO, IEMG, SCHE |
| Sector | Ticker |
|---|---|
| U.S. High Quality Bnds | AGG, BND |
| U.S. Municipal Bonds | MUB, TFI |
| U.S. Inflation-Protected Bonds | VTIP |
| U.S. High-YIeld Corporate Bonds | HYLB, JNK, HYG |
| U.S. Short-Term Treasury Bonds | SHV |
| US Short-Term Investment-Grade Bonds | NEAR |
| International Developed Market Bonds | BNDX |
| International Emerging Market Bonds | EMB, VWOB, PCY |
Most robo-advisors invest your money in exchange-traded stock and bond funds. Some companies also include commodity, real estate and other types of ETFs as well. The list of investments offered within each company is a distinguishing feature of specific firms.
Small and mid-cap value stock funds and foreign emerging market bonds differentiate Betterment’s investments list from competitors. Other companies might not have the value offerings but might include U.S. and global real estate ETFs or commodity funds.
While some micro investing and robo-advisor apps also offer access to individual stocks like Robinhood and M1 Finance.
Wealthfront allows clients to add in ETFs to customize their portfolios, or to create new ones. Then the platform will manage the investments and rebalance them when needed.
The Services
Robo-advisors come in different categories giving clients a wide range of options. Currently, in our robo advisor comparison chart we profile roughly 17 robo-advisors. While our list of robo-advisors now includes more than 30 U.S. robo advice firms. They differ regarding key features, free services provided, minimum investment amounts and more.
Depending upon your preferences, there are many varieties from which to choose. For example, M1 Finance and SoFi Invest, offer free robo-advisors suitable for investors seeking investment management or DIY investing tools. Betterment and Ellevest are, low cost robo-advisors with access to financial advisors (Betterment charges an added fee for financial advice). Many companies now offer crypto digital coins and portfolios. While most are passively managed, some automated advisors include actively managed portfolios as well such as Titan Invest.
There’s a robo-advisor for everyone, regardless of the services and features requested.
Bonus: Robo Advisor Frequently Asked Questions
Rebalancing
All robo-advisors rebalance your investments. That means if the proportions of your funds drift from your original choices, the service will buy and sell shares to return the portfolio to your preferred allocation.
Let’s say you start with a 60% stock and 40% bond asset allocation.
Assume that stocks increase in value, more than bonds and your portfolio percentages grow to 70% stocks and 30% bonds. The platform will sell some stocks and buy more bond funds to return to your pre-decided 60% stock – 40% bond mix.
Tax-Loss Harvesting
Many robo-advisors sell losing investments and replace them with others, to offset gains and reduce your tax bill. This is called tax loss harvesting and is a strategy for taxable investment accounts.
Choose a robo-advisor in under one minute with our Robo-Advisor Selection Wizard!
Human Financial Advisors
Other robo-advisors provide users with access to financial advisors for investment-related questions. This hybrid model of digital investment advice combined with online financial planning is becoming much more popular.
There’s usually an additional fee for this service, although not always.
- Betterment offers digital customers low fee financial advice packages. While premium customers, with more than $100,000 can speak with certified financial planners for the 0.40% AUM fee.
- Ellevest has low subscription pricing beginning at $5 per month with access to financial advisors and career coaches for discounted fees.
- SoFi Automated Advising is the biggest bargain with zero investment management fees and the opportunity to schedule 1/2 hour planning meetings with CFP consultants.
Read: Robo-advisors With Human Financial Advisors
Specialty Robo-Advisors
Some digital investment managers are provided by big financial firms like Marcus Invest from Goldman Sachs or E*Trade Core Portfolios. Others are stand alone companies such as Wealthfront.
Sustainfolio is one of a handful of robos that cater to sustainable ESG investors.
While Titan Invest is a hedge-fund inspired robo advisor with much lower fees and investment minimums. Titan recently added in a variety of alternative investment strategies as well.
From Ellevest, designed for women investors to M1 Finance, the free robo-advisor with thousands of investment options, there are a wide range of choices.
Robo-Advisor Fees and Investment Minimums
Robo-advisor fees are typically lower than stand-alone financial advisors, and that’s part of their allure. Robo advisory management fees start with free platforms at:
After that they range from .15% of assets under management on up to approximately .87%. The higher fee robo-advisors typically offer more features.
The investment minimums also vary from zero at SoFi, Ellevest, Axos Invest and others to $50,000 at Vanguard Personal Advisor Services with human financial advisory services included.
Choose the best robo-advisor for you:
Financial Tools and Resources
In addition to investment management, many robo-advisors offer a slew of budgeting, retirement planning, and financial management tools. In fact, Empower (formerly Personal Capital) is known for it’s free suite of money, budgeting, investing and retirement planning tools. These are available to all investors, whether you sign up for the Empower Advisors paid services or not.
FAQ
Can you trust robo advisors and are they safe?
If you’re comfortable banking and investing online, then you can trust robo-advisors. Robo-advisors are as safe as online banking with many safeguards including encryption and two-factor authentication.
Check out the security page on each robo-advisor to review how your data and personal information will be protected. Of course, it’s also your responsibility to choose complex passwords and change them regularly.
How are robo-advisors taxed?
Rollover IRAs typically won’t be taxed while the money is in the account. As long as the rollover is completed within the 60-day window, you won’t be taxed on the “withdrawal” from the original account.
Income taxes will be due on withdrawals from traditional and rollover IRAs that were funded with pre-tax dollars. Since Roth IRA contributions were already taxed, their withdrawals are tax-free.
Robo-advisors owned within typical brokerage, trust, business and other types of taxable accounts will receive a 1099 with the taxable income listed. These dividends, interest and capital gains payments are taxed in the same way as other income from investment and bank accounts.
Can you lose money with robo-advisors?
Should I Use a Robo-Advisor – Wrap up?
Are you wondering, Is investing with a robo-advisor worth it? The answer is yes, if you are seeking low-cost, research supported investment management, then a robo-advisor makes sense.
As a final wrap-up here’s who benefits from investing with a robo-advisor:
- The new investor, that wants to get started in the financial markets.
- The seasoned investor who wants a portion or all of their money on auto-pilot and invested using a sound, researched-based investment approach.
- Retirees who want special guidance or an income stream like the one available at Schwab Intelligent Income.
- The investor who wants rebalancing plus the opportunity to pick stocks and funds themselves. This customization is available at M1 Finance as well as at the robos from major brokerages such as Merrill Lynch Guided Investing.
- Fee-conscious investors who want financial advice for a reasonable fee along with well-managed investment portfolios.
For help wading through the vast pool of robo-advisors, check out our free Robo-Advisor Comparison chart:
Related:
- 10 Best Financial Planning Apps
- 7 Best Robo-Advisors for Millennials
- Personal Capital Retirement Planner
- Best Robo-Advisors for Beginners
- 8 Major Differences Between Robo-Advisors
- 5 Robo-Advisors With Downside Risk Protection
Disclosure: Please note that this article may contain affiliate links which means that – at zero cost to you – I might earn a commission if you sign up or buy through the affiliate link. That said, I never recommend anything I don’t believe is valuable.
