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

July 31, 2018
Advisors, Investing
what-is-a-robo-advisor
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If you’ve ever wished for a robot to clean your house or walk your dog when it rains, 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 arguably even more valuable: a relatively hands-off way to invest.

Robo-advisors — also known as automated investing or online advisors — use computer algorithms and advanced software to build and manage an investment portfolio for you. They offer a range of services from automatic rebalancing to tax optimization, and require little to no human interaction — but many allow you to communicate with a human when you have questions.

Because they offer low costs and low or no minimums, robos let you get started quickly. That’s important, because missing out on stock market gains can really starve your retirement.

What robo-advisors cost

This kind of management isn’t free, of course. But robo-advisors are cheaper than what you’d pay a human financial advisor, often by a long shot. Most companies charge between 0.25% and 0.89% as an annual management fee, which is paid as a percentage of your assets under the robo-advisor’s care. That means on an account balance of $10,000, you might pay as little as $25 a year. The fee typically is swept from your account, prorated and charged monthly or quarterly.

What you won’t usually pay at a robo-advisor are transaction fees. 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.

How robo-advisors work

Most robo-advisors manage both individual retirement accounts and taxable accounts. Some also manage trusts, and a select few will help manage your 401(k). Pay close attention to minimum investment requirements, which can range from $0 to $10,000 or more.

When you sign up with a robo-advisor, your first interaction will almost always be an onboarding questionnaire, designed to feel out your risk tolerance, goals and investing preferences. 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 these questions, though you should be able to veto that recommendation if you’d prefer a different option.

If you indicate in the onboarding survey that your goal is retirement in five years or that you’re saving to buy a house in three, you’ll be directed toward the conservative end of the spectrum, with a portfolio heavily weighted toward bonds and even cash. If retirement is in 30 years, the advisor will direct you toward a more aggressive portfolio lined with stocks. You can also have multiple accounts — say, a taxable account for your 10-year-anniversary cruise and a retirement account — with a different portfolio allocation for each.

Robo-advisors largely build their portfolios out of low-cost exchange-traded funds and index funds, which are baskets of investments that track an index, like the Standard & Poor’s 500. An S&P 500 ETF would aim to mirror the behavior of that index, investing in the stocks of the 500 companies within it. You’ll pay the fees charged by those funds — called expense ratios — in addition to the robo-advisor’s management fee.

» Read why robo-advisor performance is just one piece of the puzzle.

Typical robo-advisor services

The formula for many of these advisors is the same: automate investment management services so they can be done by a computer at a lower cost. At most robo-advisors, you can expect:

  • A recommendation of a diversified portfolio that aligns with your goals and risk tolerance
  • 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-loss harvesting and other tax-strategy offerings on taxable accounts

There are also services that function as cyborg-like hybrids, relying on computer algorithms in the background but offering clients access to human financial advisors, either on an unlimited basis or via a set number of phone calls throughout the year.

You can expect the cost and minimum investment requirements of these services to increase in step with the level of human involvement. Personal Capital offers dedicated financial advisors, requires a $100,000 initial deposit and charges 0.89% per year. Vanguard Personal Advisor Services and Charles Schwab Intelligent Advisory both offer access to a rotating cast of advisors for a lower minimum deposit and fee. Vanguard requires a $50,000 minimum and charges 0.30% per year; Schwab requires $25,000 and charges 0.28%.

These hybrid services can be a good option because they at least partially fill in the major gap left by strictly digital robo-advisors: Some investors want, and need, human interaction.

» Rather choose your own investments? See our best online stock brokerages

» Not sure what type of help you want? See our guide on how to choose a financial advisor that’s right for you.

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