Investing with robo-advisors has become very popular in recent years to save money while investing. Until a few years ago, you had to pay large fees to have a professional financial advisor manage your investments. Now, a robo-advisor can essentially do the same service for a fraction of the cost. If you have been considering switching to a robo-advisor (or recently started using one), this guide can help you understand what exactly is a robo-advisor and how they differ from a traditional DIY investment account.
What is a Robo-Advisor?
At first thought, having a computer manage your investments might seem a little scary. Truth is, many mutual funds rely on computers to execute a trade in a split second and maintain proper asset allocation. In today’s trading environment, human traders can no longer trade quicker than computers to find unnoticed pockets of profit.
A robo-advisor is very similar to using a financial advisor. The only difference is the cost. Using a financial advisor will cost at least 1.35% of your portfolio value each year. With a robo-advisor, the annual management can be as low as 0.25% plus expenses charged by each ETF in your portfolio. With those expense fees, every $10,000 will cost you approximately $135 (1.35%) and $25 (0.25%) annually.
Over the course of a lifetime, that’s a lot of money that could have been invested instead of paying a broker’s salary. The same thing goes for active mutual funds vs index mutual funds. Index funds invest in many of the same companies as an active mutual fund for a significantly lower cost.
What do Robo-Advisors Invest In?
Robo-advisors invest in ETFs (exchange traded funds). They are very similar to a mutual fund because they invest in dozens or hundreds of companies but they trade like a stock. That means they can be bought or sold anytime the market is open instead of after the market closes. Robo-advisors use ETFs because they are cheaper than most mutual funds (active & index funds) meaning investment costs are kept as low as possible.
When you start investing with a robo-advisor, you will complete an investment questionnaire to determine your investment goals. You would complete this same questionnaire if you used a financial advisor or opened your own DIY account. You will probably get the same answers for how to allocate your portfolio (i.e. 80% stocks, 20% bonds) and the recommended percentages of large cap, mid cap, small cap, and international stocks. The only difference is that these DIY & financial advisor alternatives will recommend more expensive investment options in most instances.
Robo-Investing Has a Human Touch
Not every robo-advisor is strictly 100% automated. If you have a certain account balance or for an additional fee, you can have access to a certified financial planner that will review your portfolio. This is still a good option if you want an extra set of eyes on your portfolio and still want to talk to a human at least once a year about your investing objectives. And, this is still cheaper than using a financial advisor for many people.
In fact, even many of the major brokerages such as Schwab, Vanguard, and TD Ameritrade have introduced robo-managed portfolios that also offer access to financial advisors. This can be a good balance between DIY investing (lowest investment costs) and having a financial advisor do everything for you (the most expensive option).
The Best Robo-Investors
There are new robo-advisor services starting up all the time. Here a few good ones to get you started:
Betterment is probably most well-known robo-advisor. Their annual account fees start at 0.25% and they don’t have a minimum account balance requirement or minimum initial investment. You can also get access to a CFP when you have assets of at least $100,000 with an annual management fee of 0.40%.
Read our Betterment Review to learn more.
Wealthfront will invest your first $10,000 for free. After that, the fee is 0.25% annually. Read our Wealthfront Review to learn more
If you want to invest your money & track your entire net worth all in the same place, Personal Capital is a good place to consider. You can track your net worth for free & all investing plans have access to a financial advisor. The annual fees start at 0.89% which is higher than the others. Read our Personal Capital Review to learn more!
WiseBanyan is the first fee-free robo-advisor. You still have to pay the ETF account fees, but, they don’t charge an account management fees. Instead, they make their money from add-on services like tax-loss harvesting. This is arguably the cheapest robo-advisor once you have more than $10,000 in assets. Read our WiseBanyan Review to learn more!
Alternatives to Investing with Robo-Advisors
You don’t need a robo-advisor to automate your investing. Investing with robo-advisors is still a relatively new concept and they haven’t been tested long-term. But, since most of the investing world is automated, it might not be as risky as you think.
Here are some ways you can invest at a low-cost by yourself.
- Index mutual funds or Index ETFs have fees as low as those invested in robo-advisors. You can even invest in the same funds as the robo-advisors without the management fee. But, you will be responsible for rebalancing the portfolio.
- Target Date Funds are also a good investment option for your 401k. They automatically shift your asset allocation from stocks to bonds as you near retirement. Because they are still managed by a human fund advisor their costs are often higher than robo-advisors.
- Using a human financial advisor is the most expensive option, but, it’s a good option if you want that regular human interaction. Here are some tips to choosing a good financial advisor that will put your interest first and be the best “return on your investment.”
Investing with robo-advisors can be an effective way to invest at the lowest possible cost & still let an “expert” make those hard investing decisions. While robo-advisors are still new, many services have a large number of satisfied customers. So, they can be a good alternative to complete DIY investing or using a financial advisor.