What Is a Robo-Advisor?

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Updated on Tuesday, December 11, 2018

Investing might feel intimidating. Choosing where every single dollar goes based on your knowledge of the stock market can scare many away from investing at all. But with robo-advisors, you don’t have to make as many decisions — you just have to pick an advisor and fund your account.

How do you know if a robo-advisor is right for your money? Learn what it is, how it works, how much it’ll cost you and what you need to get started.

What is a robo-advisor?

Robo-advisors are automated online investment platforms that automatically create a portfolio for you and invest the money you add to the account. When you create your account, most robo-advisors ask you to fill out some information about what type of investor you are. The bigger risk-taker you are, the more aggressive your portfolio will be. The more conservative you are, the less risky your portfolio is.

There are plenty of robo-advisors to choose from. Popular ones such as Betterment, Wealthfront and Acorns are attractive because of low fees and easy-to-use platforms, but most digital advisors have low or no minimum account requirements. This is attractive to newbies who don’t have a lot of extra cash but understand the importance of investing for the long-term.

ProsCons

Typically lower fees than online brokerages

Lack of help for specific needs

Instant portfolio diversification

Limited capabilities; made for the masses

Can start investing with a small amount

May offer fewer services than a human advisor

24/7 accessibility

No human interaction

How robo-advisors work

With almost any robo-advisor, you’ll complete a questionnaire that determines your investment habits and financial situation. This happens through automated software to make sure your investments are tailored to your personal needs and goals.

Once you’ve completed your answers and add money to your account, your investment portfolio, typically made up of low-cost exchange-traded funds (ETFs) and mutual funds, is created.

These investments can help keep costs low and diversify your account. ETFs and mutual funds are some of the best ways to spread your money out through many different types of assets and securities, such as stocks, bonds, real estate, industries, commodities and others.

Making sure your money is distributed into multiple types of assets can help mitigate risk. Unless you’re an expert or well-versed in one security or company, you’re going to have a hard time making sure your money lasts long-term. Diversifying, or spreading your money out among many different assets, is important for long-term growth.

This is a big differentiator from human advisors: Robo-advisors believe low-cost ETFs are good enough for most people. Human advisors select your portfolio based on your specific goals and needs. Robo-advisors try to do this, but they tailor to the masses — instead of someone hand-picking the right portfolio for you, a robo-advisor may place you in a pre-set portfolio based on your level of risk. If you have other assets, you happened to receive a large inheritance, or you have other investments you track, a robo-advisor might not work for you.

But if you’re a Millennial with a little bit of extra cash, a robo-advisor may be perfect for you. Many offer a slew of retirement options, like:

For many investors, these options are enough. Some robo-advisors offer more or less, so if you have a specific preference, it’s best to check with a company before signing up. For example, Betterment offers access to human financial advisors if you need it, and Wealthfront offers a 529 plan to save for college.

Robo-advisor fees

Just like with any company you work with, fees vary based on which one you choose. But for the most part, robo-advisors are cheaper than human advisors — mostly because robots are cheaper to maintain than humans.

Some robo-advisors charge lower fees than others; some have a few small fees while others charge one flat fee. Fees often range from 0.08% to 0.30%, depending on the company you choose, how much you invest and the level of advising you prefer. Look out for:

  • Annual fees: Many robo-advisors charge an annual fee, usually as a percentage of the money you’ve invested. For example, if a company charges you 0.25% of your investments and you have $5,000 invested, you’re paying about $12 a year. Sometimes this comes out monthly (so about $1 a month) or quarterly.
  • Advice fees: If you want to talk to a human advisor, some robo-advisor offer that upgrade for a fee. For example, you can talk to a financial expert at Betterment for $149.
  • Trading fees: Some companies charge transaction fees, which is a cost-per-trade. Many big robo-advisors waive these, but some don’t.

Comparatively, brokerage fees can be as high as 2%. For that $5,000 you’ve invested, that’s $100 in fees.

When reviewing robo-advisors, check for an account minimum needed. Acorns and WiseBanyan require $1 to start; Wealthfront requires $500. How much money you have to start might determine which robo-advisor you choose.

Is robo-advising right for you?

Before you sign up with a robo-advisor, make sure you’ve answered a few questions about yourself, including:

  • How much money do I have? If you have a few bucks or a couple hundred dollars, starting to invest with a robo-advisor is a good idea. If you have a lot of assets and money, you might benefit more from a live person to help manage your affairs.
  • Can I afford the fees? Robo-advisor fees are usually lower than human advisors or online brokerages. But if you’re not comfortable paying them, you might want to stick to other methods, such as a certificate of deposit (CD).
  • Am I OK with a computer managing my investments? If you’re comfortable with passive management and slowly growing your money, a robo-advisor is a good fit. If you like to be hands-on and specific about the types of securities you want to put your money in, you might be better off with a different approach.

Robo-advisors are a great option for newbie investors or those with limited assets. They’re a helpful way for many people who haven’t otherwise invested to get started. But they aren’t for everyone. When evaluating robo-advisors, make sure you choose one that’s best for your financial situation, not everyone else’s.

Fees mentioned in this article are accurate as of the date of publishing.

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