What Is a Robo-Advisor and Is One Right for You?
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If you’ve ever wished for a robot to clean your house or walk your dog, you’ll likely understand the appeal of a robo-advisor. These services don’t do windows or pet-sit, but what they do offer is a relatively hands-off way to invest.
Robo-advisor definition
A robo-advisor — also known as an automated investing service — is a service that uses computer algorithms and software to build and manage your investment portfolio. Services can include automatic rebalancing and tax optimization. Robo-advisors require little to no human interaction, but many robo-advisors have human advisors available for questions.
Traditional portfolio management services often require high balances, but robo-advisors typically have low or no minimum requirement. Because of that and their low costs, robo-advisors let you get started investing quickly — in many cases, within a matter of minutes. Also, if you want to grow your wealth but are unsure how to start, robo-advisors can be one way for beginners to start investing.
» Ready to get started? Check out NerdWallet's picks for the year's best robo-advisors
How much does a robo-advisor cost?
Most robo-advisors charge an annual management fee of 0.25% to 0.50%. This is usually much cheaper than in-person human financial advisors.
As with many other financial advisors, robo-advisor fees are a percentage of your assets under the robo-advisor’s care. For example, for an account balance of $10,000, you might pay as little as $25 a year. The fee is typically deducted from your account, prorated and charged monthly or quarterly.
You won’t usually pay transaction fees with a robo-advisor. In a standard brokerage account, you might pay a commission to buy or sell investments, both during a rebalancing of your portfolio and when you deposit or withdraw money. Robo-advisors frequently waive these charges.
You will probably pay fees (called expense ratios) on the exchange-traded funds (ETFs) and index funds the robo-advisor offers. These are in addition to the robo-advisor's management fee.
Some robo-advisors require an initial investment of $5,000 or more, but some have no account minimum and others have account minimums of $100-$500.
» Read more: How much does a financial advisor cost?
How does a robo-advisor work?
When you sign up with a robo-advisor, your first interaction will almost always be a questionnaire designed to learn your risk tolerance, goals and investing preferences.
Robo-advisors then build a portfolio out of low-cost exchange-traded funds (ETFs) and index funds, which are baskets of investments that aim to mirror the performance of a stock market index, such as the S&P 500. Robo-advisors generally offer between five and 10 portfolio choices, ranging from conservative to aggressive. The service’s algorithm will recommend a portfolio based on your answers to the questionnaire, but you should be able to veto that recommendation if you’d prefer a different option.
The business strategy for many advisors is the same: automate investment management so it can be done by a computer at a lower cost. At most robo-advisors, you can expect:
Regular rebalancing of that portfolio, either automatically or at set intervals — for example, quarterly. Most advisors do this via computer algorithm, so your portfolio never gets out of whack from its original allocation.
Financial planning tools, such as retirement calculators.
Tax strategies, such as tax-loss harvesting, which involves selling losing investments at a loss to offset capital gains taxes on sales of profitable investments.
Most robo-advisors manage individual retirement accounts (IRAs) and taxable accounts. Some also manage trusts, and a select few will help manage your 401(k). It comes down to whether you want automated portfolio management.
If you'd prefer to pick your own investments, opening a brokerage account might be a better option. You can find online stock brokers who offer $0 account minimums and free trades. You'll have to do the research on stocks yourself and manage your own portfolio, but you'll skip some of the fees that can come with robo-advisors. (Read our primer on how to invest in stocks for more on DIY investing.)
» Not sure which type of advisor is right for you? Learn how to choose a financial advisor
Pros and cons of a robo-advisor
Whether a robo-advisor is right for you depends on what you need from a financial advisor and how involved you prefer to be in the day-to-day management of your money.
Usually less expensive than an in-person human advisor.
Low or no account minimums.
Hands-off, set-it-and-forget-it approach can save you time.
Can get started quickly.
No human day-to-day involvement.
Investment options may be relatively limited.
May not be able to manage all types of accounts.
If you don't want to manage your own portfolio but you want or need more comprehensive financial planning than a robo can provide, here's one middle-ground option: online financial planning services.
What are online planning services?
Online planning services operate as online financial advisors, and they're sort of a robo-advisor/traditional advisor hybrid. You'll receive unlimited access to a team of financial planners (or, in many cases, your own dedicated financial advisor), but you'll meet virtually via phone or video rather than in person. This model means you get human oversight and interaction at a higher cost than a robo but at a lower cost than a traditional financial advisor.
You can expect the cost and minimum investment requirements of online financial advisors to increase with the level of human involvement, certification (such as access to a certified financial planner) and personalization:
Facet Wealth charges $2,100 to $6,600 per year, based on the complexity of your planning needs. You get custom advice and a complete financial plan, and the service includes investment management.
Charles Schwab Intelligent Portfolios Premium offers access to a team of advisors who will prepare a custom financial plan for you and manage your portfolio. Schwab requires a $25,000 account balance and charges a flat fee of $30 a month plus a one-time planning charge of $300.
Vanguard Personal Advisor offers access to a team of financial advisors for a $50,000 account minimum and an annual fee of 0.30% to 0.31%. You'll get a customized financial plan, portfolio management and access to financial planning tools.
» View a full list of the best financial advisors
These hybrid services can be an additional option because they at least partially fill in the major gap left by strictly digital robo-advisors: Some investors want and need human interaction.