What is a robo-advisor?

How robo-advisors work

Robo-advisors automatically invest your money and manage your investment accounts without the need for human guidance. They use advanced algorithms to guide investing decisions, choose your investment portfolio and help you set financial goals.

Here’s how the process works:

1. Sign up and answer questions. You can typically sign up for a robo-advisor for free, and then you’ll need to answer a few survey questions for the platform to understand your investing goals and risk profile. This helps the robo-advisor choose a well-suited investment portfolio based on your answers.
2. Finalize your portfolio. Once a portfolio is presented, you can make any last-minute tweaks to the asset allocation or choose another portfolio you think is a better fit. These portfolios typically consist of low-cost exchange-traded funds (ETFs) across stocks, bonds and other asset classes.
3. Automate your savings. Once you’ve chosen a portfolio, you can set up a recurring investment amount and schedule. Most robo-advisors encourage dollar-cost averaging, which helps you invest on a regular basis over a long period of time.
4. Rebalance automatically. The robo-advisor will track your asset allocation (the percentage split between each investment). If one or more investments grows or shrinks above or below the target asset allocation, your robo-advisor will rebalance the portfolio to get you back in line with your target. This is done automatically when you make a deposit or buy/sell assets within your portfolio.
5. Track your goals. Robo-advisors usually have a dashboard that helps you track your investing goals. This may include tracking how much is invested in each account, your progress toward retirement and how close you are to maxing out tax-advantaged accounts (such as an IRA).

Robo-advisor vs. brokerage account

A robo-advisor is an automated investment platform that builds a portfolio for you to invest in and collects a fee for managing your investments. While you have some flexibility to choose your investments, most of the process is handled by the robo-advisor. 

With a brokerage account, you have all the control without the guidance from a professional. This means you can pick and choose your investments, create your own custom investment portfolio and handle the day-to-day investment decisions. But everything is manual, from executing trades to rebalancing, setting goals and tax planning.

• A robo-advisor is ideal for hands-off investors who want help creating an investment plan and setting goals.
• A brokerage account is ideal for DIY investors who don’t mind picking and choosing investments and handling all the investment decisions.

» COMPARE: Best online stockbrokers for beginners

Common robo-advisor features

Robo-advisors are designed to help guide you through creating an investment plan and making investment purchases. They also offer a wide range of planning services.

How much do robo-advisors cost?

Robo-advisors typically charge an assets-under-management (AUM) fee, which is a percentage of the money that is being managed by the robo-advisor. While fees for a financial advisor can range from 0.80% to 1.50% (or more), robo-advisors typically charge around 0.30% or less. This makes a robo-advisor a much less expensive option than a traditional financial planner.

Most robo-advisors charge a fee for full management, but not all. For example, M1 Finance has a free account option. It’s not a fully managed account, but it does let you choose a prebuilt portofolio, set up automatic rebalancing and automate your investments.

Schwab Intelligent Portfolios, Fidelity Go and SoFi Automated Investing have free options as well. Schwab and Fidelity offer free robo-advisor accounts up to a certain account balance, while SoFi doesn’t charge at all. All of these options do use proprietary funds in your portfolio, so they are still making money.

Benefits of using a robo-advisor

“Robo-advisors are an excellent solution when someone is just looking for investment help,” said Michael Mezheritskiy, a financial planner and the founder of Milestone Asset Management Group. “They use low-cost index funds, don’t have any transaction fees, you can purchase fractional shares, and they have a great and modern interface.”

Using a robo-advisor can be advantageous to beginners and hands-off investors who want guidance in building an investment portfolio.

Here are a few benefits of using a robo-advisor:

• Easily accessible to novice investors
• Lower fees and minimum investment requirements
• Automated diversification and risk management
• Reduced emotional decision-making
• User-friendly platforms
• Tax-friendly investing strategies available

Considerations when choosing a robo-advisor

Here are a few factors to consider when choosing a robo-advisor:

• Fees and fee structures. It’s important to know how your robo-advisor gets paid. Review the fee structure (typically a percentage of your holdings), but also review any miscellaneous fees for services used.
• Investment philosophy/strategy. Most robo-advisors follow some version of modern portfolio theory, which focuses on low-cost index funds and asset allocation strategies. But make sure to read up on your chosen robo-advisor’s investment philosophy before investing your money.
• User experience. Is the app easy to use or confusing? It’s important that a robo-advisor makes it easy to understand your investments and goals, and you can easily navigate the platform to manage your account.
• Customer service. Robo-advisors try to automate as much as possible, but if you have a question, can you talk to an actual human? Find a robo-advisor that offers the level of customer service you are comfortable with.

» COMPARE: Best robo-advisors

When to choose a human advisor over a robo-advisor

Robo-advisors can be a great option for investors who want some guidance on investing decisions and financial planning but don’t have a lot of complicated planning scenarios. Investors who prefer a simple automated investing strategy with low fees may do well with a robo-advisor as well.

But if you’re looking for a more detailed financial planning approach, a human advisor may be a better option. Here are a few scenarios where a human advisor may benefit you more than a robo-advisor:

• You want estate planning
• You run a business
• You want advanced tax planning
• You need trust fund administration
• You want detailed retirement drawdown strategies
• You want more control to react to unexpected situations

And if you just want more personalized service and someone to talk to about your investing decisions, a financial advisor can be a good idea.

Mezheritskiy said there are many scenarios where a robo-advisor doesn’t make sense. For example, he said most people usually need help with things such as:

• How do I pay off my debt?
• What’s the best way to save for college?
• When should I start collecting Social Security and why?
• How can we use proactive tax planning to reduce my tax obligations later?

“This is when a human fee-only fiduciary is needed and cannot be replaced by a robot,” he said.

Working with a licensed financial advisor or planner who has a certified financial planner (CFP) designation or is a fiduciary is your best bet. They are required by law to put your best interests first and can help you craft a full financial plan that goes beyond just managing your investments.

» MORE: How to manage your money

Bottom line

Robo-advisors offer a cost-effective and user-friendly way for hands-off investors to manage their portfolios. However, those with complex financial needs may benefit more from a human advisor who can offer personalized guidance and a broader range of services.

The choice between robo-advisors and human advisors depends on your willingness to research your own investments, create investing goals and keep an eye on your retirement.