A robo-advisor (also sometimes spelled as roboadvisor) is a digital platform that provides automated, algorithm-driven financial planning and investment services with little to no human supervision. A typical robo-advisor asks questions about your financial situation and future goals through an online survey. It then uses the data to offer advice and automatically invest for you.
Other common designations for robo-advisors include “automated investment advisor,” “automated investment management,” and “digital advice platforms.”
The best robo-advisors offer easy account setup, robust goal planning, account services, and portfolio management. Additionally, they offer security features, comprehensive education, and low fees.
- Robo-advisors are digital platforms that provide automated, algorithmic investment services with minimal human supervision.
- They often automate and optimize passive indexing strategies based on modern portfolio theory.
- Robo-advisors are often inexpensive and require low opening balances, making them available to retail investors.
- They are best suited for traditional investing and aren’t the best options for more complex issues, such as estate planning.
- Robo-advisors have been criticized for their lack of empathy and complexity.
Click Play to Learn About Using Robo-Advisors
Robo-Advisors: History and Investing Strategy
The first robo-advisors, Betterment and Wealthfront, launched in 2008. Wealthfront began as a mutual fund company. It planned to assist the tech community, then realized that computer software could make investment advice more accessible. Betterment, on the other hand, began with the initial purpose of rebalancing assets within target-date funds (TDFs). It sought to help manage passive, buy-and-hold investments through a simple online interface.
The technology was nothing new. Human wealth managers had been using automated portfolio allocation software since the early 2000s. But until Betterment and Wealthfront launched, wealth managers were the only ones who could buy the technology, so clients had to employ a financial advisor to benefit from the innovation.
Today, most robo-advisors use passive indexing strategies that are optimized using some variant of modern portfolio theory (MPT). Typically, the account holder can’t choose which mutual funds or exchange-traded funds (ETFs) to invest in, or purchase individual stocks or bonds in their account.
Some robo-advisors offer optimized portfolios for socially responsible investing (SRI), halal investing, or tactical strategies that mimic hedge funds. They also can handle much more sophisticated tasks, such as tax-loss harvesting, investment selection, and retirement planning.
The industry has experienced explosive growth. Client assets managed by robo-advisors are expected to reach $3 trillion in 2023, and $5 trillion worldwide by 2027.
As of December 2022, the largest robo-advisor by assets under management (AUM) was Vanguard Digital Advisor, with $140.7 billion.
The majority of robo-advisors use modern portfolio theory (or some variant) to build passive, indexed portfolios for their users.
Once portfolios are established, robo-advisors continue to monitor them to ensure that the optimal asset-class weightings are maintained, even after market moves. Robo-advisors achieve this by using rebalancing bands.
In rebalancing bands, every asset class, or individual security, is given a target weight and a corresponding tolerance range. For example, an allocation strategy might include the requirement to hold 30% in emerging market equities, 30% in domestic blue chips, and 40% in government bonds with a corridor of ±5% for each asset class.
The use of rebalancing bands means that, given the ±5% corridor, emerging market and domestic blue-chip holdings can fluctuate between 25% and 35%. Government bonds can fluctuate between 35% and 45%. When the weight of a holding moves outside of the allowable band, the entire portfolio is rebalanced to reflect the initial target composition.
In the past, this type of subtle rebalancing was frowned upon because it was time-consuming and generated transaction fees. However, low-fee robo-advisors are designed to handle rebalancing automatically.
Another type of rebalancing commonly found with robo-advisors—made cost-effective through algorithms—is tax-loss harvesting. Tax-loss harvesting is a strategy that involves selling securities at a loss to offset a capital-gains tax liability.
This strategy is typically employed to limit the recognition of short-term capital gains. Robo-advisors do this by maintaining two or more stable ETFs for each asset class. So, if the S&P 500 ETF loses value, a robo-advisor will automatically sell it to lock in a capital loss; simultaneously, it buys a different S&P 500 ETF.
It’s worth bearing in mind that the IRS wash-sale rule prevents investors from re-purchasing the same security or a security that is substantially identical within 30 days from its sell date. However, robo-investment platforms should have algorithms in place that incorporate rules like this.
Make sure your robo-advisor is programmed to select ETFs appropriately so that you avoid wash- sale violations.
Benefits of Robo-Advisors vs. Traditional Financial Advisors
The emergence of robo-advisors has broken down some of the traditional barriers between the financial services world and average consumers. Because of these online platforms, sound financial planning is now accessible to almost everyone, not just high-net-worth individuals.
- Robo-advisors are low-cost alternatives to traditional advisors. By eliminating human labor, online platforms can offer the same services at a fraction of the cost.
- Most robo-advisors charge annual flat fees of less than 0.4% per specific amount managed. That is much less than the typical 1% charged by a human financial planner (or more for commission-based accounts).
- With robo-advisors, it’s generally easier to keep tabs on investments. You can log in 24/7 as long as you have an internet connection.
- It takes significantly less capital to start investing when using robo-advisors. One of the most popular robo-advisors, Betterment, has no account minimum for its basic account offering.
- Robo-advisors are efficient. Before robo-advisors and online brokerage accounts, if you wanted to execute a trade, you’d have to call or meet with a financial advisor, explain your needs, and wait for them to execute your trades. Now, you can do all of that with the click of a few buttons in the comfort of your home.
- Though using a robo-advisor may limit your investment options, this can be beneficial because buying individual stocks or trying to beat the market can produce poor results. On average, ordinary investors often see better results with an indexing strategy.
Some human advisors won’t take on clients with less than $25,000, $50,000, or maybe even $100,000 in investable assets.
Limitations of Robo-Advisors
- Many in the industry have doubts about the viability of digital advisors as a one-size-fits-all solution to wealth management.
- Given their current technological capabilities and minimal human presence, robo-advisors have been criticized for lacking empathy and sophistication.
- Robo-advisors are good entry-level options if you have a small account and limited investment experience. You may find them lacking if you need services like estate planning, complicated tax management, trust fund administration, and retirement planning.
- Automated services are also ill-equipped to deal with unexpected crises or extraordinary situations. For example, robo-advisors won’t know if you’re between jobs or dealing with an unexpected expense—your funds could be drained unexpectedly by automatic withdrawals.
- A study conducted by Investopedia and the Financial Planning Association found that consumers prefer a combination of human and technological guidance, especially when times are rough. According to the report, 40% of participants said they wouldn’t be comfortable using an automated investing platform during extreme market volatility.
- Robo-advisors operate on the assumption that you have defined goals and a clear understanding of your financial circumstances, investment concepts, and potential investment outcomes. For many investors, that is not the case.
Convenient, easy access
Lower cost, low starting capital
Investment experience not required
Straightforward index investing
Growing number of valuable services
Lacks human interaction
Limited investment opportunities
Investor must define financial situation and investment goals
One-size-approach not right for all
Uneven technology standards
Hiring a Robo-Advisor
Robo advisors don’t all cost the same amount and offer all the same features. Each one may excel in particular areas, so it’s important to do some research first. Dedicating a bit of time to finding the right one could turn out to be one of your smartest investments.
There are also hybrid robo-advisors, which essentially seek to combine the benefits of automated investment with human financial advice.
Opening a robo-advisor account usually entails completing a short, risk-profiling questionnaire and evaluating your financial situation, time horizon, and personal investment goals. In many cases, you will have the opportunity to link your bank account directly for quick and easy funding of your robo-advisory account.
Many digital platforms target and attract certain demographics more than others. For robo-advisors, these include Millennial and Generation Z investors who are technology-savvy and still accumulating their investable assets.
This population is much more comfortable sharing personal information online and entrusting technology with essential tasks, such as wealth management. Indeed, the marketing efforts of robo-advisory firms typically employ social media channels to reach these investors.
The U.S. Securities and Exchange Commission (SEC) issued a risk alert to investors in November 2021 regarding compliance issues with many robo-advisors. Be sure to stay informed of these and other issues by checking FINRA Investor Alerts and the SEC Division of Examination websites for information.
Robo-Advisors and Regulation
Robo-advisors hold the same legal status as human advisors. Accordingly, they must be registered with the SEC and are subject to the same securities laws and regulations as traditional broker-dealers.
Most robo-advisors are members of the Financial Industry Regulatory Authority (FINRA). You can use BrokerCheck to research robo-advisors in the same way that you would a human advisor.
Assets managed by robo-advisors aren’t insured by the Federal Deposit Insurance Corp. (FDIC). That’s because they are securities held for investment purposes, not bank deposits.
However, this doesn’t necessarily mean clients are unprotected. For example, Wealthfront is insured by the Securities Investor Protection Corp. (SIPC), meaning that if the company goes bust, investors will be reimbursed up to $500,000 of their invested balance. As you research robo-advisors, don’t forget to check on the kind of insurance each has to protect your investment.
How Robo-Advisors Get Paid
The primary way that most robo-advisors get paid is through a wrap fee based on assets under management (AUM). While traditional (human) financial advisors typically charge 1% or more of AUM per year, many robo-advisors charge around 0.3% of AUM per year.
Another revenue stream is payment for order flow (PFOF). This payment (typically fractions of a penny per share) results from directing trade orders to a particular market maker. PFOF can potentially result in better execution prices for clients. Typically, robo-advisors bundle various trade orders together into large block orders executed just one or two times a day.
Finally, robo-advisors can earn money by marketing targeted financial products and services to their customers, such as mortgages, credit cards, or insurance policies. This is often done through strategic partnerships rather than advertising networks.
If the costs of your robo-advisor outweigh returns on your investments, then you may be better off not using one.
The Best-in-Class Robo-Advisors
There are hundreds of robo-advisors available in the U.S. and worldwide. More of them launch every year. They all provide some combination of investment management, retirement planning, and general financial advice.
Here is a compilation of the most competitive robo-advisor companies with the largest market shares. Before investing, please check with those robo-advisors of interest to you for any updated information.
These firms are some of the pioneers of digital advisory technology. They have the most competitive fees with low to zero account minimums. Clients with no current invested assets can start from scratch with these platforms.
|Robo-Advisor||AUM||Features||Annual Fee||Account Minimum||Investopedia Rating|
|Betterment||$36 billion||Adjust portfolios to accommodate new goals and risk tolerance, tax-loss harvesting; SRI portfolios.||0.25% (annual) for investing plan accounts with at least $20,000 or at least $250 per month in recurring account deposits. Otherwise, the fee is $4/month.||$0, $10 minimum to start investing.||4.5/5|
|Wealthfront||$34 billion||Customize portfolio with ETFs and cryptocurrency funds; tax optimization; digital financial planning tool.||0.25% of account balance.||$500||4.8/5|
|Interactive Advisors||Not available||Lots of choice including fractional shares; research and screening tools; socially conscious focus.||0.08%-0.75% per year, depending on advisor and portfolio chosen.||$100 – $50,000||4.2/5|
|Ally Managed Portfolios||$12.8 billion||Invest with little; SRI options; change investment strategy.||0.30% of assets under management for low cash allocations, free of advisory fees for portfolios with 30% cash.||$0 to open, $100 to invest.||4/5|
|Acorns||$6.2 billion||Millennial-focused; unique investment strategy via “spare change” of expenses.||$3–5 / month.||None.||N/A|
|M1 Finance||$5.5 billion||Extensive portfolio management customization options; margin loans; low cost.||0%||$100 ($500 minimum for retirement accounts).||4.2/5|
|SigFig||$2.3 billion||Competitive fees; retirement planning; access to advisor; tax optimization.||0.25% (first $10,000 is free).||$2,000||3.9/5|
|Axos Invest Managed Portfolios (Formerly WiseBanyan)||$154.5 million||Multiple asset classes; tax- loss harvesting.||0.24% AUM on account balances above $500 and $1 per month on balances under $500.||$500||3.5/5|
Pay attention to what a robo-advisor invests in, as some are now moving away from passive index strategies and investing in more risky areas that could underperform the market.
Established Firms’ Robo-Advisors
An increasing number of financial services and asset management firms are launching robo-advisors. These platforms typically have higher fees and account minimums and are geared more toward sophisticated investors. They are convenient options for clients who already use these firms as asset custodians.
|Established Firms’ Robo-Advisors|
|Robo-Advisor||AUM||Features||Annual Fee||Account Minimum||Investopedia Rating|
|Vanguard Personal Advisor Services||$140.7 billion||Every client is matched with an advisor; tiered services; one-time financial plan.||0.30% of assets under management (excluding cash) for up to $5 million; management fee tiers down to 0.16% for assets over $25 million.||$50,000||4.1/5|
|Schwab Intelligent Portfolios||$70.3 billion||Overall planning; ETF selection; IRAs.||$0, expense ratios range from 0.03%-0.18%. ($300 setup plus $30 per month for Premium).||$5,000 ($25,000 for Premium).||4.2/5|
|Fidelity Go||Not available||Millennial-focused; low-cost mutual funds / ETFs.||0.35%, annual fee charged for balances over $25,000.||$0 to open an account, $10 to be invested.||4.2/5|
|Empower||$23.5 billion||Free money management tools; easy-to-use website; tax minimization strategies.||Ranging from 0.89% for the first $1 million to 0.49% for accounts over $10 million.||$100,000||4.2/5|
|Merrill Guided Investing||Not available||Lots of educational resources; actively managed portfolios.||Annual 0.45% of assets under management, assessed monthly. With advisor—0.85%.||$1,000 or $20,000 with an advisor.||4.4/5|
|TD Ameritrade Essential Portfolios||Not available||Millennial-focused; low-cost ETFs backed by Morningstar; tax-loss harvesting.||0.30% of assets managed per year.||$500 with automatic recurring investment, otherwise $5,000.||3.7/5|
|E-Trade Core Portfolios||Not available||Newer investors; SRI options available.||0.3%||$500||3.9/5|
What Does a Robo-Advisor Do?
Robo-advisors provide financial planning services through automated algorithms with no human intervention. They start by gathering information from a client through an online survey and then automatically invest for the client based on that data. Robo-advisors often use passive index investing strategies.
Can Robo-Advisors Make You Money?
Yes, you can make money with a robo-advisor, as you can with any other financial advisor.
Can You Lose Money With Robo-Advisors?
Yes, you can lose money with robo-advisors if investments lose value or costs outpace portfolio returns.
Do Robo-Advisors Beat the Market?
Most robo-advisors won’t beat the market. That’s because their investing involves a passive index strategy that seeks only to replicate the market’s return. Typically, robo-advisor investing is based on modern portfolio theory, which relates to constructing a portfolio that maximizes return within an acceptable level of risk.
The Bottom Line
Robo-advisors leverage advances in algorithmic trading and electronic markets to automate investment strategies for ordinary investors.
Often based on modern portfolio theory, robo-advisors are able to optimize investors’ risk-return tradeoffs and automatically manage and rebalance their portfolios. Automation also allows for tax-loss harvesting and other strategies that were once too complex or expensive for ordinary investors.
With low fees and small minimum balances required to get started, robo-advisors may be a good choice for most long-term investors and may be especially attractive to younger, tech-forward individuals.