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 manage your investments.
Robo-advisors are angling to replace human financial advisors, at least when it comes to investment advice. Also known as automated investing or online advisors, robo-advisors use computer algorithms and advanced software to build and manage a client’s investment portfolios, offering everything from automatic rebalancing to tax optimization. They require — and often offer — little to no human interaction.
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 0.50% 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 $25 to $50 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.
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.
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.