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.

A robo-advisor — also known as an automated investing service — is a service that uses algorithms and software to build and manage your investment portfolios. Many robo-advisors also perform automatic rebalancing and tax optimization.

Robo-advisors typically have low or no minimum account balance requirements. This, and the relatively low costs, allow people, especially beginners, to start investing quickly, even in a matter of minutes.

However, most robo-advisors provide little to no human interaction. Some have human advisors available for questions, but this access is typically a paid upgrade or available only if you have an account balance over a certain amount.

» Ready to get started? Check out NerdWallet's picks for the best robo-advisors

Robo-advisor costs

Most robo-advisors charge an annual management fee of 0.25% to 0.50% of your account balance. This is usually much cheaper than what human financial advisors charge.

There are four types of robo-advisor fees to consider.

• Asset management fees. Similar to human financial advisors, robo-advisors typically charge a percentage of your assets under management, called an AUM fee. For example, the typical robo-advisor fee works out to $125 to $250 a year on a $50,000 account balance or $25 to $50 a year for a $10,000 account balance. The fee is usually deducted from your account, prorated and charged monthly or quarterly.

• Trading fees. You won’t usually pay transaction fees to buy or sell investments with a robo-advisor. If you're considering a robo-advisor that charges these fees, it may be a sign to look elsewhere.

• Expense ratios. These are paid on exchange-traded funds (ETFs) and index funds that the robo-advisor includes in your portfolio. They’re in addition to the robo-advisor's management fee. A traditional financial advisor would also pass these fees along to you. (For more information on these, read our full article about expense ratios and how they might affect your returns.)

• Fee changes based on account minimums. Some robo-advisors require an initial investment of a few thousand dollars. Others have no account minimum or minimums of a few hundred dollars. In some cases, you'll pay one fee — often a flat fee — until you accumulate a certain amount of money, and then switch to a different fee structure, typically an AUM fee. Be sure you understand what fee you're paying based on the amount of money you plan to invest.

» 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 at a lower cost.

When you sign up with a robo-advisor, you'll likely answer a questionnaire designed to learn your risk tolerance, goals and investing preferences.

The algorithm uses the information to build a portfolio out of low-cost exchange-traded funds (ETFs) and index funds. These are baskets of investments that typically 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. Risk levels also range from conservative to aggressive. The service’s algorithm will recommend a portfolio based on your answers to the questionnaire, but you can veto that recommendation if you’d prefer something else.

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). This ensures your portfolio maintains its original allocation and is done by algorithm.

• Access to financial planning tools, such as retirement calculators.

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

Most robo-advisors will manage individual retirement accounts (IRAs) and taxable brokerage accounts. Some also manage trusts, and a select few will help manage or at least provide investment advice for your 401(k).

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 management of your money.

» Not sure which type of advisor is right for you? Learn how to choose a financial advisor.

Alternatives to a robo-advisor

If you don’t want to manage your own portfolio, but don't feel like you need all the services a financial advisor would provide, you might be interested in a bit of a hybrid option — services that use automated portfolio management like robo-advisors, but give you access to a team of financial advisors for when you need personalized advice. Services in this realm include:

• Vanguard Personal Advisor, which 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 get a customized financial plan, portfolio management and access to financial planning tools.

• Betterment Premium offers unlimited phone access to a team of certified financial planners for a $100,000 account minimum and an annual fee of 0.65% (for balances under $1 million). You get all the features of Betterment’s lower-tier robo offering, plus the financial planning tools of the premium service and access to financial advisors.

• Empower Personal Strategy offers dedicated advisors for balances of $250,000 or more. Under this amount, clients get access to a team of advisors. Account management fees range from 0.49% to 0.89%, also depending on account balance, and the service has a $100,000 account minimum.