Financial advisors guide investment strategy and stock selection efforts. These professionals spend their careers learning to research, time, and assess the market and manage stock and bond positions.
Unfortunately, financial planning services can be prohibitively expensive for many investors. Traditional financial advisors may charge a flat or percentage management fee for their services. Many managed funds also have high minimum deposits that put them out of reach for most investors.
Robo-advisor services provide advisory or brokerage services to investors. These are automated investing services relying on algorithms to select assets and manage portfolios.
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The lower costs and lack of high deposit requirements make these services much more accessible than working with a human advisor.
How Popular are Robo-Advisors?
Many investors embrace robo-advisors. The automated sites currently manage a combined $1 trillion in wealth in the US. Experts predict the figure to rise to $3.22 trillion by 2027. Many people who use these services are younger investors who do not have the capital to use traditional investment management services.
Clients are usually adept at navigating digital environments and comfortable with algorithm-based platforms. Though these services are available to everyone, clients with less online experience may have to negotiate a steeper learning curve.
Some banks and investment platforms offer both human and algorithm-based advisory services. However, some newer sites rely solely on robo-advisors to manage client funds.
Here is a closer look at how these platforms handle investment management, the cost, and the different options they offer to clients.
A Closer Look at How Automated Investment Advisor Services Work
Robo-advisors work by collecting data from clients and inputting it into complex algorithms. Financial experts design these equations to select specific investments and personalized advice based on the provided information.
The system weighs many different variables. For example, you enter data about your income, financial goals, risk tolerance, and areas of interest. After getting this information, some robo-advisor services will automatically invest your funds for you, while others offer a range of options matching your profile.
The algorithms are well-researched and based on existing investing principles. Many of the complex equations on these platforms rely on widely-accepted economists’ theories. Harry Markowitz’s Modern Portfolio Theory (MPT) is an example of a philosophy guiding robo-advisor algorithm creation.
The automated features vary from platform to platform. Some only provide investment advice, while others offer additional services, such as tax loss harvesting and portfolio rebalancing.
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How Did the Robo-Advisor Trend Start?
Robo-advisors began in the late 2000s as a new option for underserved investors. Companies like Betterment and Wealthfront saw that traditional financial advisor business models did not meet the needs of a majority of investors. They were too expensive, leaving younger investors with limited capital to figure out the complex world of stocks and funds on their own.
The 2008 financial crisis also played a role in the growth of automated investment advisors. People flocked to these services to avoid the risks of investment portfolio mismanagement by human advisors, which was behind the 2008 real estate market crash.
The popularity of these original robo-advisors caused traditional banks and brokers to notice. Many added automated options to their regular human financial advisor offerings. This trend has led to more than 100 robo-advisor options worldwide. The challenge for today’s investors is not finding an automated investment help platform but choosing the best option from the many possibilities.
What Is the Process for Using a Robo-Advisor?
They may offer different services, but most robo-advisors follow the same basic process for collecting data, offering investment insights, and building portfolios. After opening an account and adding information to confirm your identity, you will need to answer a variety of questions. The software will enter the data from your inputs into the robo-advisor’s algorithms.
What questions will you answer? The site will ask you about your income, the amount of capital you wish to invest, the regularity of your deposits, and your financial goals. The site will also assess your risk tolerance, which is how much you are willing to lose if investments do not go your way.
You will have to decide whether you are willing to take on more risk for greater potential rewards or if you would like to accept slower, steadier profits with less risk.
After collecting data and putting it through the algorithm, the site will suggest an investment strategy, offer specific stocks or funds, or even automatically divide your capital between assets to create a balanced portfolio. Some sites will create the portfolio for you, while others will allow you to select from a list of options or choose your own investments.
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What Features Do Robo-Advisors Offer?
One of the more important considerations when selecting a robo-advisor is the features it offers. Every investor needs different tools depending on their experience, how involved they want to be in the process, and the amount of capital. Here are some common features and which types of investors generally find them valuable.
Round-Ups and Automatic Deposits
Robo-advisor services like Acorns allow you to round up every purchase with connected debit cards to the nearest dollar. The site then automatically puts these extra cents into your chosen assets.
Most robo-advisors allow you to set up automatic deposits from a connected bank account to help with consistent deposits. These tools can help very new investors build their portfolios. However, many investors prefer manual deposits.
Automatic Portfolio Rebalancing
Portfolio rebalancing involves buying and selling shares to maintain a diversified set of investments. This step is essential when some assets rise or fall in value. Automatic rebalancing handles this process automatically so that you do not have to track your investments every day.
Most sites offer rebalancing as a free, standard feature. It can be useful for managing your account, even if you track your investments regularly. You will not need to make complex calculations to do the job manually.
At the end of the year, you can claim your investment losses on your taxes, potentially lowering your taxable income. Tax-loss harvesting involves the strategic sale of assets to lower your tax bill.
This service comes standard on mid-range and premium accounts. However, it is quite rare if you have a basic robo-advisor account. This tool is typically more beneficial if you have a larger investment account, so the advantages are limited for those who are just starting.
One feature basic robo-advisors may have that many premium sites do not is fractional shares. The site purchases shares of companies and allows users to buy parts of these shares. This option can be useful for new investors who want to purchase blue-chip stocks with $100-plus share prices.
With this feature, you can take advantage of price movements as you build your portfolio rather than being limited to cheaper stocks that are less likely to increase in value. However, if you have enough capital to purchase full shares, this option is not useful.
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Examples of Robo-Advisor Services
Here is a look at the different services you can expect from robo-advisor platforms. These all feature automated investment advice, but their other traits vary significantly.
Full-service robo-advisors like Betterment draw clients with an array of automated features and $0 deposit requirements. Betterment offers investing advice, and, like many robo-advisors, it provides fractional shares to allow investing with minimal capital. This class of platforms also has a few premium features, like tax-loss harvesting and automatic rebalancing.
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Some robo-advisor services serve as brokerages, too. M1 Finance is an example of this option. M1 is for investors who want the choice to get automated advice, but are also interested in making their own choices. Such platforms are also excellent for novices who want to use robo-advisors when learning about markets and then manage their own trades once getting experience.
Wealthfront is an example of a mid-range robo-advisor. It offers more premium features but comes with a $500 minimum deposit. The capital requirement is still modest enough for most investors. Some extras include interest-bearing cash management, a wider range of exchange-traded funds, tax-loss harvesting, and the ability to borrow against your account. You also get more comprehensive customer support than totally-free platforms.
Premium robo-advisor platforms come with more significant capital requirements. For example, Personal Capital has a $100,000 deposit minimum. Most of these high-end platforms are actually hybrid services. In addition to robo-advisor options, you also get access to traditional financial professional services. Personal Capital offers unlimited access to human advisors in addition to all the automated features you would expect.
Acorns is an example of a company that offers to deposit your change from each purchase and invest it in stocks or ETFs. Users answer questions about their financial plans, and Acorns offers insights about creating a portfolio that can help them achieve these financial goals.
This simple robo-option is user-friendly because it features a bank account with a debit card and uses a subscription model ($3-$5 per month) instead of charging management fees.
The Costs of Using a Robo-Advisor
Are robo-advisors worth it? Robo-advisor sites are more accessible than traditional financial advisors. However, you should be aware of the cost of using these tools. Here is a look at the different expenses you should weigh when opening an account.
Deposit requirements are the first cost to consider when choosing a robo-advisor. However, it is not the only variable affecting your choice.
Many basic services have no deposit minimum. You can open an account and add funds at your discretion. Other sites require a token deposit of $1 to get started. In general, these sites offer simple services and a limited selection of investments.
Novices will typically not miss any additional features offered by higher-end platforms when they start investing. However, if you open an account, you may eventually grow out of the site and need to move your money to a more full-featured site.
- A few basic robo-advisor sites offer additional services for a fee or if you meet a higher balance requirement. However, the free or low-priced versions typically only provide a few features.
- Mid-range sites have higher balance requirements, ranging from $500 to $10,000. These companies offer more comprehensive financial planning tools, access to more ETFs and mutual funds, and the ability to use human advisors.
- Full-service investment advisor companies like Personal Capital provide a hybrid automated/human platform. To get these advanced services, you need to deposit $10,000 to $100,000.
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The Management Fee
Most financial service providers charge a management fee. This cost compensates the people running the site and updating the automated features.
In general, robo-advisors provide services for less than traditional advisors. However, this is not always the case. The in-person professionals at Vanguard Personal Advisor Services charge 0.3% of your capital as a fee for management. In comparison, Betterment charges 0.25%. You can contrast these costs with fully-managed investment accounts, which often charge fees of 2%.
A robo-advisor’s management fee can vary. Some companies, such as Acorns, charge monthly fees instead of taking a percentage. This may or may not be cheaper depending on your account balance.
Some services charge monthly fees, which are similar to memberships or subscriptions. You may need to calculate if this is cheaper than paying a management fee.
In general, if you have a higher balance, subscription fees will be cheaper than management fees. However, subscription sites often come with limited services and fewer asset classes.
Pros and Cons of Robo-Advisors
Here is a look at the pros and cons of robo-advisor platforms so that you can decide if they are the right option for you.
- Costs – Robo-advisors offer financial services for less than human financial planning professionals.
- Convenience – These platforms automate many of the time-intensive aspects of investing, allowing you to select investments quickly and manage your portfolio.
- Accessibility – With smartphone apps, connected bank accounts, and automated features, these sites make investing accessible for tech-savvy users and those who do not want traditional advisors.
- Lack of personalization – Robo-advisors do not offer the same level of subjectivity as human investment advisers.
- Limited assets – Many robo-advisors offer stocks, ETFs, and mutual funds, but you may not have access to derivatives, bonds, REITs, or other investment vehicles.