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Robo-Advisors vs Index Funds – Which are Best? - Robo-Advisor Pros
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Robo-Advisors vs Index Funds – Which are Best?

Last Updated on December 12, 2020 by Barbara A. Friedberg, MBA, MS

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

Robo advisors have revolutionized investing during the last decade. You can invest your money in a robo-advisor or index fund for low or no fees.

If that weren’t enough happy news for investors, most of the major brokerage houses also offer comission-free stock and fund trading!

Both do-it-yourself investors and those seeking low fee investment management have many choices.

When I first started investing, (don’t ask me how long ago that was) you could easily pay a $50 commission to buy stock shares or mutual funds. And forget about fractional shares, they didn’t exist.

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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.

Today, I have accounts at Vanguard, Fidelity, Schwab, M1 Finance, Axos Invest, and TIAA and can buy and sell stocks and ETFs commission-free. My robo-advisor accounts at Schwab and M1 Finance offer free investment management and zero commissions for trades.

The right choice between a robo advisor or index fund depends upon your your financial goals, preferences, and experience. Discover whether it’s best for you to invest in a robo-advisor who will manage your investments, or simply to choose index funds and invest on your own.

What is a Robo Advisor?

A robo-advisor is a digital financial manager.

After answering a few questions about your financial goals and risk tolerance, the computerized algorithm creates a group of diversified investments, called a portfolio, designed to give you good investment returns, that align with your stated preferences.

In plain English, that means that you receive a portfolio of stock, bond, and possibly alternative investments in accord with your goals and comfort with risk. These investments are managed by the computer and designed to help you build wealth for the long term.

The best robo-advisors are feature-rich with easy onboarding, educational information, diversified investment choices, a functional mobile app, and easy-to-access customer service. All robo-advisors rebalance your portfolio to keep it in line with your preferred asset allocation.

Fortunately for you, there is a long list of robo-advisors from which to choose, with an abundance of features.

The types of robo-advisors include:

What is an Index Fund?

An index fund is an investment portfolio which contains stocks or bonds that approximate those owned by an unmanaged index.

Indexes, of similar types of securities, like the S&P 500, are created to give investors a way to examine how certain sections of the investment markets behave. You read that the DOW or the S&P 500 went up and you understand that the aggregate group of stocks, within the index increased in value.

Some of the most popular indexes are:

  • S&P 500 – 500 of the most important companies in the US
  • Dow Jones Industrial Average or DOW – 30 of the largest companies that trade on the New York Stock Exchange
  • Russell 2000 – 2000 small capitalization stocks
  • NASDAQ Composite – 2500 of the stocks listed on the Nasdaq stock market exchange.
  • Bloomberg Barclays U.S. Aggregate Float Adjusted Index – Investment-grade U.S. bond market

There are hundreds of index funds capturing a wide range of market indexes, both broad and narrow.

You can pick and choose index funds for your own account or else choose a robo-advisor. Most robo-advisors also offer index funds in their client portfolios.

The Case for Indexing with Either a Do-it-Yourself Approach or a Robo-Advisor

Actively managed funds attempt to “beat the market” returns, and typically fail.

The reason that index funds are so popular is because of their long term returns. Many researchers have compared the returns of actively managed funds with those of passively managed index funds that simply copy the investments within a specific benchmarket index.

Over long periods of time, passive index fund investing with index funds have outperformed actively managed funds 60-80% of the time, according to Vanguard research. And the tricky part is that even if one actively managed fund outperformed it’s index one year, it was unlikely to repeat the outperformance the next.

Fortunately for investors, you have a choice – you can invest in index funds on your own or you can use a robo-advisor or digital investment manager. And, most robos also invest in index funds, on your behalf.

Either way, you get the beneifits of passive index fund investing.

Top Robo-Advisors

Robo AdvisorManagement FeeInvestment Minimum
m1 finance image
M1 Finance
$0.00$100Sign up
$0.00$1.00Sign up
wealthfront review logo
Wealthfront
0.25% of AUM ($5,000 managed for free)$500Sign up
ellevest logo$5-$9 per month NoneSign up
schwab intelligent portfolios logoBasic-$0.00 Premium-$30/month ($300 set up fee)$5,000Sign up
Betterment logo0.25% of AUM for accounts worth more than $20,000 | $4.00 for accounts worth less than $20,000None - $10 to begin investingSign up

Robo Advisors vs Index Funds-How to Decide

So, which is better for you, investing on your own or letting a digital investment manager do the heavy lifting?

There are many things to consider when deciding whether to do-it-yourself and invest with index funds or even a target date fund or two.

Although, you’d think cost would be a concern, with fee-free robo-advisors and low minimums, even that doesn’t need to be a factor.

Next we’ll break down the similarities and differences between the do-it-yourself index fund investing or the robo choice.

What are the Differences?

How to Invest in Index Funds

For DIY investors in index funds, you’ll open an investment brokerage account with a financial firm, or an app like Robinhood.

Next, screen for index fund investments that meet your goals. Typically you choose diversified low cost index funds from the US and international stock markets, bond index funds and maybe REIT (real estate investment trust) and commodity index funds.

Then you’ll buy shares in these index fund investments in the proportions that fit in with your goals and timeline. You can choose from either low-cost ETFs or mutual funds.

Investing on your own requires basic financial education. It’s important to learn before you invest. These are a few of my favorite investing books: Elements of Investing and Invest and Beat the Pros.

You’ll also need to understand asset allocation which is a fancy way of explaining what percent of your investments go into various segments of the markets like stocks or bonds.

Although, if you want to bypass fund selection you could choose a target date fund. This type of managed fund owns both stocks and bonds and has a “target” retirement date. This is the date when the investor expects to begin withdrawals from the fund.

The asset allocation in a target date fund begins more aggressively with a greater allocation to stock investments and becomes more conservative, with more bonds as the target date nears. Investors may even use target date funds for other intermediate and long term financial goals.

Compare: Robo-Advisor vs Target Date Fund

If you’re comfortable with choosing index funds on your own and you have an idea of which of the many types to choose. then index fund investing might be for you.

How to Invest in Robo-Advisors

The first step in choosing an automated investment manager is figuring out which one is right for you. You might consider using our robo-advisor selection wizard to help you choose. Also, you can sign up for the Robo-Advisor Comparison Chart.

If you know you want live financial advice and investment management, then you could simply sign up with SoFi Invest or Betterment.

If you want access to both a robo-advisor and index funds within one platform, then consider M1 Finance.

After you’ve selected the a robo-advisor, the sign up is very easy.

Log in, answer a few questions about your goals and risk tolerance, link your bank account, transfer funds and you’re done.

The robo-advisor does the rest!

There are so many robo-advisors with various features, that most investors will find one to suit their needs.

FAQ

Do robo-advisors beat the market?

Robo-advisors typically match the market returns, which is quite good. Over the long term, stock market has returned roughly 9% and bonds approximately 5%.

Why are robo-advisors bad?

We believe robo-advisors are generally a good investment management solution for a wide range of individuals. Like any investment in the financial markets, during certain periods investment values decline. But, during the long term, most robo-advisors offer excellent market-matching returns.

Are index funds better than stocks?

Each are appropriate for a specific type of investor. With index funds you typically get excellent diversification. Investing in individual stocks requires research and experience. With individual stock investing it’s important to own several stocks from diverse industries to get broad diversification.

Are robo-advisors better than target date funds?

Robo investing is better if you’re seeking more diverse investment choices, financial advice, tax loss harvesting, lending, cash management, and more features. While target date funds are fine for those who want a diversified stock and bond portfolio that is automatically adjusted as the target date grows closer.

Robo-Advisors vs Index Funds – Final Decision

The decision regarding whether to choose do-it-yourself index fund investing or go with a low fee investment manager boils down to your own preferences.

Figure out what you’re looking for and how much time you wish to devote to investment management.

Then, consider a few other factors like investment account choices, fees, tax loss harvesting, and investing style.

Check out robo-advisor FAQ for answers to all of your questions.

Whether you choose to invest on your own in index funds or with a robo-advisor – or both – the most important thing to do with your money is start inveting now!

How to Choose a Robo-Advisor

6 Best Robo Advisor Apps

Socially Responsible Robo Advisors

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

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Barbara A. Friedberg, MBA, MS


Barbara Friedberg, MBA, MS brings decades of finance and investing experience to Robo-advisor Pros. She is a former investment portfolio manager and taught Finance and Investments at several universities. Barbara Friedberg's published work includes Personal Finance; An Encyclopedia of Modern Money Management (Greenwood Press), Invest and Beat the Pros-Create and Manage a Successful Investment Portfolio and How to Get Rich; Without Winning the Lottery. Follow her on twitter