What Is a Robo-Advisor? 6 Of Your Top Questions Answered

If you’ve considered buckling down and getting serious about your portfolio, it’s likely you’ve come across the term “robo-advisor” before. What is a robo-advisor exactly, and how do you know if one is right for you? We’ve got your answers below.

What Is a Robo-Advisor?

A robo-advisor is also known as an automated investing service or online advisor. Instead of having an individual, such as yourself or an advisor, build and manage an investment portfolio, a robo-advisor does so using algorithms and computer software.

Robo-advisors typically include limited interaction with an advisor, and they can be set up quickly (often in just a couple of minutes). 

Common Questions About Robo-Advisors, Answered

Below we’ve rounded up our answers to the most common questions we hear about robo-advisors.

1. What Are the Advantages of Using a Robo-Advisor?

One of the most prominent advantages of using a robo-advisor is the account minimum requirements. Some have no minimums at all, while others will let anyone start investing with just a few thousand dollars. This can be an appealing alternative for investors (such as young professionals) who have not yet acquired the assets needed to hire an investment advisor (since many advisors have minimum AUM, or Asset Under Management, requirements to work with them). 

Robo-advisors can help reduce the chance of human error or behavioral bias. They’re automated and use algorithms to invest, making it hard for an investor to make a mistake or gut reaction on their end. It takes the emotional response to market changes out of the equation. While you may be inclined to change your strategy based on what you see on the news, a software program isn’t. 

Robo-advisors are also an ideal way to simply “set it and forget it.” They’re typically programmed to automatically rebalance, without a need for you to take any action. 

2. What Are the Disadvantages of Using a Robo-Advisor?

Robo-advisors really can’t replace the one-on-one, tailored advice and strategies of an investment advisor. If your investment needs are more complex, or you’re looking to integrate your portfolio into the rest of your financial plan, a robo-advisor may not offer what you’re looking for.

If you have multiple accounts, like a company 401(k) plan, a robo-advisor also may not be able to accommodate these different investment accounts. If you need to integrate these various accounts, you’ll likely want to work with an advisor directly.

3. Who Primarily Uses Robo-Advisors?

Robo-advisors could be considered a “happy medium” between DIY investing on your own and hiring a professional financial advisor. It can be a big time saver and cost-effective option for those who have a simple investment strategy and/or are just looking to automate their investments. In addition, robo-advisors are advantageous for young investors who don’t have the assets or net worth needed to hire an investment advisor, but still would like to get started building a portfolio.

4. What Does a Robo-Advisor Cost?

Robo-advisors vary in cost, but the fee structure is similar across the board. Most robo-advisor services charge a percentage of the assets under management. This is typically anywhere between 0.25 percent and 0.50 percent, but some providers could charge more.

In addition, you may have to pay any fees associated with the investments themselves (such as an expense ratio). 

Some providers may offer robo-advisor services as a flat fee for users, rather than a percentage of the assets under management. 

5. What Services Does a Robo-Advisor Offer?

Robo-advisors are available through a number of providers, and the services they offer may differ. Common services to look for include:

• Automatic rebalancing of your portfolio (or rebalancing set at regular intervals)
• Tools you can use for other financial planning services (such as a retirement calculator)
• Tax-loss harvesting

6. What Are the Alternatives to Using a Robo-Advisor?

If you’re interested in investing but don’t believe a robo-advisor is a good fit for your needs, you primarily have two options to choose from.

You can work one-on-one with an investment or financial advisor to develop a customized, tailored portfolio. This is a much more personalized approach, and it involves utilizing the expertise and guidance of an industry professional. Some advisors now incorporate robo advisor platforms into their own offerings, allowing them to work with younger clients (or those who don't yet meet their asset minimums). 

The other option is to take an entirely do-it-yourself (DIY) approach to your investments. This would include researching and selecting all of your investments (stocks, bonds, real estate, etc.) on your own. Some investors choose to work with a financial planner to build a comprehensive financial plan, but choose to take an entirely DIY approach to their portfolio.

Selecting a robo-advisor, especially if you’re investing with a smaller amount upfront, can be an opportune way to begin building your portfolio. If you’re unsure of whether one is right for you or not, start by comparing and contrasting robo-advisors on the market. And if you’re currently working with an advisor, they may be able to help you decide what would work best for your unique investment needs.

For more information, check out my video below:

Keith Wilson, CLTC