What Is a Robo-Advisor and Is One Right for You?

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 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.

However, robo-advisors provide little to no human interaction. Some robo-advisors have human advisors available for questions. But access to those professionals may require that you meet certain balance requirements or pay extra fees.

» 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 financial advisors. There are four types of fees to consider.

• Asset management fees. As with many other financial advisors, robo-advisor fees are typically a percentage of your assets under the robo-advisor’s care. For example, for an account balance of $10,000, you might pay $25 a year. The fee is typically deducted from your account, prorated and charged monthly or quarterly.

• Trading fees. 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.

• Expense ratios. 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.

• Account minimums. Some robo-advisors require an initial investment of a few thousand dollars, but some have no account minimum and others have account minimums of a few hundred dollars.

» Read more: How much does a financial advisor cost?

How does a robo-advisor work?

The business strategy for many advisors is the same: automate investment management so it can be done by a computer at a lower cost.

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 use that information to 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.

At most robo-advisors, you can expect:

• Regular rebalancing of that portfolio, either upon some sort of trigger or at set intervals (quarterly, for example), so your portfolio never gets out of whack from its original allocation. This is typically done via an algorithm.

• Financial planning tools, such as retirement calculators.

• Automated or optional tax-optimization strategies, such as tax-loss harvesting, which involves selling losing investments at a loss to offset capital gains taxes on sales of profitable investments.

Some robo-advisors may 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.

» 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 and how involved you prefer to be in the day-to-day management of your money.

If you don't want to manage your own portfolio but you want or need more comprehensive financial planning than a robo can provide, it may suit you better to find a human financial advisor.

Many financial advisors have embraced automated portfolio management like robos, which has brought down the cost of their services. (Financial advisors charge around 1% of assets under management on average — but costs can be as low as 0.30%.)