If you’re interested in personal finance and investing but are just diving into the world of FinTech (financial technology), you may have heard about robo-advisors.
You’ll often hear the term thrown around in the same sentences as “automated investing” or “automated financial advisors.” You most likely landed on this page because you searched for the answer to what these services are.
So, what exactly, is a Robo-Advisor?
Robo-advisors use special algorithms to evaluate and manage your investment portfolios. These algorithms determine the best financial strategy for your account. They operate efficiently and at a far lower cost than human financial advisors.
Robo-advisors are generally restricted to the area of investment management and retirement planning. Even though they usually don’t handle cash-flow management or estate planning (with some exceptions), their services are quickly expanding. Many of them now have 529 college savings accounts, 401(k) management, micro-investing, and more.
Using a robo-advisor can radically change the effectiveness of your investment accounts. Back in the day, this level of service was only available through a financial advisor as part of a more expensive bundle of services.
Thanks to robo-advisors, automated portfolio management is now available to a larger network of investors. And they’re much less expensive than a human financial advisor.
Are robo-advisors better than a personal financial advisor?
We’re not saying that robo-advisors are better than a personal financial advisor. Still, there are clear advantages that robo-advisors have over human advisors:
- Robo-advisors open new doors to smaller investors, who could only get market guidance through traditional methods.
- Access to advanced advisory services, even with a lower account balance.
- The automation provides lower transaction fees.
- Lower management fees equal a more opportunity to grow – especially for big portfolios.
- Low barrier of entry: many robo-advisors have low or no minimum investment.
- Protects investors from avoidable risks such as greed and conflict of interest.
What is a hybrid robo-advisor?
A hybrid robo-advisor combines the ease and lower costs of a robo-advisor with the added insight and planning from a human advisor.
For some investors, trusting an algorithm doesn’t seem like the best option. You may want additional human interaction, advice, and guidance, especially if you have a diverse investment portfolio.
Hybrid robo-advisors like Personal Capital and Vanguard PAS have the benefits of automation while providing qualified human advice where you need it. Typically, you’ll pay higher fees, so this type of robo-advisor is great for investors who will use the services offered.
How do Robo Advisors Work?
The exact workings of the robo-advisors will differ depending on the service that you choose to use. However, they generally operate on the same principles.
Most robo-advisors give the investor an automated, hands-off option to managed investing, whether you’re starting small or if you have larger amounts to invest.
This is precisely why you should read our expert robo-advisor reviews. We provide in-depth reports on the best robo-advisors in the industry so you can determine the best investment service for your specific financial needs and budget.
What happens when I sign up?
After signing up, you’ll answer a few important questions about your budget, investment goals, and risk tolerance. The robo-advisor will suggest a portfolio composed of various stocks, bonds, and ETFs (exchange-traded funds). Then all you’ll need to do is deposit or transfer the preferred investment amount. As you deposit money into your new investment account, the robo-advisor will allocate your assets across your portfolio of investments based on similar algorithms that traditional financial advisors often use.
Usually, those investments consist of different low-cost stock and bond ETFs, and the individual allocations and selections will differ from one investor to another.
However, asset allocation is just the tip of the iceberg. They also provide many other account services, which we cover in our reviews and other pages on this website.
What do robo-advisors offer investors?
Robo-advisors provide a wide range of wealth management products and services. Many of them can also provide automatic rebalancing, dividend reinvestment, and tax loss harvesting – benefits that were previously exclusive to expensive financial planners.
Automated portfolio rebalancing is when a robo-advisor automatically adjusts the allocation of assets within an investor’s portfolio to maximize returns. Usually, your account is rebalanced monthly to keep you on the right path towards your financial goals. You can learn more about automatic portfolio rebalancing here.
Dividend reinvestment is when the service recognizes the pay-out of a dividend, assesses the best way to reinvest that money, and then goes ahead and does so automatically without any direction from you. This helps keep your portfolio from holding too much cash, which isn’t earning you any return on investment. Learn more about dividend reinvesting here.
Tax-loss harvesting is a slightly more complicated feature. In simple terms, it is the process in which the robo-advisor chooses the optimal time to sell a security that has experienced a loss. This is to offset taxes on other gains and profits. Learn more about tax-loss harvesting here.
How much do Robo Advisors cost?
Compared to a human investment advisor, robo-advisors are budget-friendly investment tools.
The exact cost depends on which robo-advisor you choose, of course. On average, you should expect a robo-advisor to cost between 0.25% and 0.50% of your account balance annually. This fee is much less compared to those of mutual funds.
There are even some free robo-advisors that provide quality services with no strings attached! Companies offering a free service have other financial services that earn the company a profit. Others only charge fees after your portfolio reaches a certain balance- typically over $5,000 or $10,000. You can find an analysis of our favorite robo advisors with the lowest fees here.
Fees eat away at your bottom line
And that’s just with 1% fees; some financial advisors charge much more. With lower fees, you keep more of your earnings and can invest your savings!
The cost of an automated investing service is generally referred to as management fees. Fees are either charged as a flat monthly fee or as a percentage of your account balance.
According to Bloomberg, traditional brokerage firms such as Morgan Stanley, Bank of America, and Wells Fargo are under pressure to justify the high fees they charge investors. Even they are scrambling to develop automated advisory services for their customers. In 2020, Statista reported that the number of people using a robo-advisor is up 33% year-over-year, and assets under management (AUM) have increased by 12.4% YoY. And that growth hasn’t shown any signs of slowing down.
Robo advisors are growing fast, especially among younger generations. We’re dedicated to providing you with comprehensive and expert reviews and guides to the best robo-advisors online.
Are robo advisors worth it?
By now, you might be wondering if a robo-advisor is worth the effort and fees. We believe that they offer valuable services that can automate and grow your investments, financial advice, help you save for retirement, and make big purchases. Regardless of your financial situation, a robo-advisor can help you save more and grow your savings over time.
According to the Federal Deposit Insurance Corp (FDIC), the average interest rate for savings accounts is 0.05% APY in the US. That means if you keep $1,000 in a savings account, you’ll earn $0.50 per year. If two extra quarters a year doesn’t get you excited, investing your money, especially with a free robo-advisor, is typically a better choice.
Although the past performance of investments doesn’t guarantee future success, it’s good to look at historical performance. When available, we include the historical returns of the robo-advisors we review. The overall average comes out to around 3.25%, sixty-five times higher than a savings account.
Which robo advisor should I use?
There are pros and cons to every robo-advisor. Before making a decision, it’s best to read a review, decide which features are important to you, and determine your budget- how much you want to invest initially.
If you’re a brand new investor, the amount of information can easily become overwhelming. You understand the importance of saving and preparing for retirement, but it’s difficult to know where to start. Check out these robo-advisors that are great for beginners.
While we can’t recommend a single robo-advisor that will work for every individual, we offer recommendations based on your investing experience and budget. And of course, we have our favorites, including M1 Finance and Wealthfront, which we think will meet most investors’ needs. But you should determine your goals and compare the financial planning features offered before making you get started.
Are robo advisors safe?
Keeping your money safe is always a top priority. In today’s digital world, nearly every bank has a mobile app offering easy access to your finances. Reputable robo-advisors implement the same level of security as your regular bank.
Robo-advisors use a TSL connection and two-factor identification- verifying your phone number or email when you sign in on a new device, to keep your information safe. You will likely need to connect your regular bank account to your new investment account, but your banking info won’t be stored in the app. You can take extra precautions such as using a unique password, updating contact info, and avoid signing in to your account on an unsecured public network.
Overall, robo-advisors offer a high level of security that you can trust. Trusted companies are also FDIC and SIPC insured, up to $250,000 for each account. The insurance doesn’t cover the value of your investments decreasing. If you buy a $100 stock and it drops to $50, don’t expect a check in the mail. The insurance covers a situation like your bank losing your money, so you can think of it as a safety net.
There are many fantastic benefits of robo-advisors and financial tools that can save you money and grow your investments. FinTech has continued advancing, and we’re looking forward to the continued development and growth of new investment management tools.
Make sure to check out our comprehensive robo-advisor reviews to learn about and compare all of the best robo-advisors.