Robo-advisors allow you to turn over your money to an automated advisor. Most robo-advisors offer asset allocation for your portfolio based on your risk level. Other potential features include automated rebalancing, tax-loss harvesting, educational tools, and more.
Robo-advisors, including Wealthfront and Betterment, aim to take on traditional financial advisors. So how do they stack up?
- Robo-advisors use automation and software algorithms to help you invest your money according to your goals.
- Typically, robo-advisors cost less than financial advisors and are able to match market returns.
- However, financial advisors are better at creating comprehensive plans for your money and choosing specific assets.
Where Robo-Advisors Shine
There are areas where a robot is a far better money manager than either a DIYer or a financial advisor. In this case, the robot is a money management platform backed by a sophisticated algorithm.
Here's where robo-advisors come out on top.
Fees and Minimums
Once the company creates the algorithm, the robo-advisor has cheap (or no) ongoing overhead costs, whereas personal financial advisors need to earn a salary every year. The average financial advisor makes almost $90,000 per year. Customers pay these salaries through an hourly fee or as a percentage of their total returns or assets. In contrast, robo-advisors' fees can go as low as 0% in the case of Schwab's Intelligent Portfolios.
Also, advisors may require clients to have a large minimum account balance. In contrast, robo-advisors come with low (or no) account minimums. This makes investing more accessible to those with less to invest.
Rebalancing refers to buying and selling investments to fine-tune your mix of stocks, bonds, and other investments. Financial experts recommend rebalancing your portfolio regularly to ensure that you retain your preferred mix of asset classes. Maintaining this diversification can reduce volatility.
You can rebalance your own portfolio or pay someone else to do it, but a robo-advisor will automatically rebalance your portfolio as needed.
Matching Market Returns of Their Benchmarks
Market-matching returns don't sound glamorous, but the allure of beating the market with active mutual funds often proves fruitless. In a 2021 study, less than half of actively managed funds managed to beat the market year-over-year, and that share falls to just 25% when looking at a 10-year period.
What Robo-Advisors Can't Do (Most of the Time)
Robo-advisors have many advantages, but there are some tasks best left to a human—particularly for the very wealthy or those with complicated needs.
Here's where robo-advisors fall short (most of the time).
Create a Comprehensive Financial Plan
If you have a high net worth, a robo-advisor may not be enough for you. You may need a trusted advisor who can examine your entire financial picture, including estate issues, taxes, trusts, and life insurance considerations. A full-service financial advisor can manage your investment portfolio while tracking your broader economic concerns.
Some robo-advisors offer some level of human assistance, but their offerings may not match the hands-on, holistic approach of financial planning professionals.
In 2022, the Securities and Exchange Commission (SEC) announced a closer examination of the advice and recommendations offered by algorithms. The SEC wants to know if algorithm-generated guidance meets a minimum standard of conduct owed to investors seeking professional advice.
Choose Specific Financial Assets
Most robo-advisors are limited in their types of available investments. These services may not work if you want to pick specific investments, such as individual stocks, bonds, currencies, or options. Robo-advisors are also less likely to offer any exposure to less common instruments like peer-to-peer lending, master limited partnerships, or closed-end funds.
If you're an active stock picker and want to work with a financial advisor in an effort to outperform the markets, then a robo-advisor isn't right for you. Most robo-advisor tools aren't flexible enough for those who want to pick their own assets.
That said, an investor has many robo-advisors to choose from. A few robo-like advisors specialize in offering more flexibility. Some traditional brokerages like Charles Schwab have begun offering automated services alongside more traditional brokerage accounts.
Beat the Market
Most robo-advisors follow an index fund investing strategy. That means that they'll closely match market performance. However, they won't beat it.
Some services, like Betterment's Smart Beta strategies, have unique algorithms that try to beat the market, but they haven't been around long enough to be proven or disproven. Then again, human advisors also have a spotty record when it comes to beating the market.
Frequently Asked Questions (FAQs)
How do robo-advisors work?
From a customer's standpoint, robo-advisors function similarly to other online banking services. Once you've opened your account and linked a source of funds, you simply transfer money in or out of the robo-advisor as you please. The robo-advisor will use an algorithm to buy investments with deposits and sell them for withdrawals.
How much can you make with robo-advisors?
How much profit you make with robo-advisors largely depends on your risk tolerance and broader market conditions. Since robo-advisors typically use passive investments, all levels of risk tolerance will make (or lose) the market average.
For example, if the broader stock market goes up 10% in a given year, a stock portfolio with a robo-advisor would likely profit about 10% (minus fees). Keep in mind that many robo-advisors also invest in other assets, like bonds or precious metals, so you'll have to account for the performance of each of those markets to estimate your robo-advisor returns.