What is a Robo-Advisor? (and Should You Be Using One)

What are “Robo-Advisors”?

What is a robo-advisor, and is one right for you? Robo-advisors are the new trend among a number of investors. Learn about what makes them so popular — and what to watch out for — below.

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Robo-advisors are actually quite simple to understand, once you break them down a bit.

In recent years, the automation of techniques and services to build and manage investment portfolios has grown significantly more popular in the wealth management industry, and robo advisors have been a key player in this shift.

With the world becoming increasingly more automated, the move towards a robot-lead finance industry was inevitable.

Although the robo-advice industry has, to date, a relatively small share of assets under management (AUM), it offers a promising proposition for investors – including a price fee reductions of as much as 66 percent in some cases. The industry’s rate of growth is not only rapid, but is increasingly accelerating.

While the initial interest in robo-advice came from the “mass-affluent delegator” market segment, a traditionally forgotten segment, there has been a strong growth, and move towards the leveraging of the more direct engagement model; In the same way, full-service advisors are utilizing robo-advice models to increase their impact on smaller accounts.

As the industry continues to evolve, the robo-advisor has had a positive impact on alleviating the stress of high fees while receiving services that once were inaccessible and out of reach for many.

This aspect of robo-advisory has introduced increased democratization to the industry, paving the way for more accessibility and inclusion, and changing the way we invest.

In the meantime, reports increasingly argue that we are only at the beginning of the robo-advisor era, including PWC’s assessment that the market is still in the early stages. Mordor Intelligence has noted that in 2019, the digital asset management market reached a value of USD 1663.78 million, and is projected to reach USD 9255.05 billion by 2025, at a CAGR of 34.1%, throughout the forecast period of 2020-2025.

Similarly, Deloitte highlights that several institutes have not only projected the future robo-advisor market to be worth between $ 2.2 trillion and 3.7 in assets under management (AUM) in 2020, but with the figure rising to $16 trillion in AUM by 2025.

Based on projections and estimations, the long term trend for robo-services will remain increasingly strong. Traders for who are more self-directed, and use tools like charts, data, fundamentals as a guide to their strategy, it might be worth your while exploring more about robo-advisors and what they can bring to the table for you in the long-term, too.

What is a Robo-Advisor and How Do They Work?

A robo-advisor is an automated service that emulates the work that a traditional financial advisor would normally do. That is, building a portfolio based on clients needs and goals, taking into account risk, by utilizing algorithms. So, how does a robo-advisor work?

What is a Robo-Advisor? Charles Schwab helps to explain it with this diagram.
Robo-advisors are very appealing to new and low-income investors because they tend to cost less and no advisory fees are charged.

Robo-services can include automatic rebalancing to tax optimization, mostly with no need to speak to a human – although there are usually some humans available if you need them, which we discuss more about further down. All of this results in a quicker and easier sign up process, allowing users to begin investing sooner, rather than later.

Generally, you’ll be asked a few quick questions to confirm your identity, followed by a questionnaire. This is mostly about your experience, financial circumstances, and your investing goals, all to help determine where you’re at in your trading journey.

This is all then balanced with your personal needs including your financial goals and your preferred time-frame for meeting these goals, in addition to how much risk you’re willing to take on against often volatile and changing forces like market conditions, and asset class performance, to name a few.

As a whole, it tries to gather a 360° analysis of you, your needs, your finances, your investing goals and your appetite for risk. Then, a robo-advisor uses this information to create a completely customized and suitable portfolio that takes all of these aspects into consideration.

In essence, a robo-advisor uses the available information to offer your advice to help grow your finances, minimize risk, and invest in assets.

At the end of the day, the robo-advisors assistance removes the need for time-consuming – and often arduous tasks, not to mention the fees – and replaces it with an automatic, stress free, efficient solution.

An in-depth look shows that robo-advisors do all this through advanced, progressive technology, such as pattern recognition and artificial intelligence, in a low cost way. Arguably, even providing better results, in less time, and with less charges than any human advisors would – perhaps robo-advisors are the win-win for the company and the client.

Interested in learning more about available robo-advisors? Check out our picks for the best robo-advisors you can find.

The Importance of The Human Element: Can You Trust Robo-Advisors?

Not so fast.

Accenture argues that there are many benefits to client-advisor relationships, in their robo-advisory analysis, The Rise of Robo-Advice. Financial advisors can provide the emotional and psychological support that’s often necessary when trading, including offering reassurance, discussing their next move or whether or not current trends are risky or beneficial.

Advisors can guide clients through difficult markets, cautioning them when necessary and synthesizing various solutions. All of which act as the foundational work of the financial advisor.

Client-advisor relationships are, therefore, becoming more recognized as an essential part of a brokerage experience for some, and a shift towards interlinking the best part of the human services with the best part of robo-capabilities.

In other words, understanding the role that robo-advice can play in enhancing both the work and client-advisor relationships is becoming more of a priority for wealth management firms.

Therefore, while the era of the robo-advisor arose from traditionally high commission charges, and the need for more diversity in their portfolios, this structure is continually growing and re-moulding itself to fit the ever changing industry. There will always be a need for human services and so, newer models offer clients a hybrid prototype that consists of both human and bot aspects – who said you can’t have it all?

As this new model moulds into its next form, the invaluable need for human advisors is being recognized by more providers, resulting in the re-emergence of human advisors. When it comes to trusting robo-advisors, some are just skeptical.

Charles Schwab’s Intelligent Advisory is an example of a form that has successfully merged financial advising and robo-advising, along with Personal Capital who offers a two fold structure that includes both robo and financial advisory services – both of which have blurred the lines of the services and the term; Personal Capital outlines that it doesn’t want to be considered a robo-advisor firm but instead, a “digital asset management service.”

The Rise of Robo-Advice – How Robo-Advisors Captured Our Attention

Some are of the opinion that robo-advice will complement, as opposed to diminish, financial advisors. Certain firms have created their own offerings, while mid-sized and larger firm’s have bought independent robo-advisory firms.

This is because clients have a complex mixture of needs, and firms are continually trying to create solutions to meet these. The robo-advice model might just be the answer for both the company and a vast selection of client types, especially for clients with simpler goals and needs, or for beginner traders.

Melanie L. Fein lays out a compelling argument in Robo-Advisors: A Closer Look, that the reason for the popularity of robo-advisors is, “Robo-advisors have emerged in the marketplace  as an alternative for small investors who are comfortable using Internet technology but want the reassurance  of an investment adviser to guide them.”

Robo-advisors are  advantageous for an abundance of reasons. Their complexity is not one, and although robo-advisors provide quite basic functions, investors, including newer investors, have not quite learned these skills yet.

In addition, high financial fees charged by financial advisors are just out of touch with what many can afford in 2020. This creates a lack of accessibility, and ultimately makes financial advisors only available for more seasoned, experienced, and/or high-net-worth investors.

Since robo-services entail little to no human interaction, they are ideal for investors looking for a more hands-off approach with the investments.

They are also beneficial for those who have more straightforward finances and goals, and may require more customized advice and guidance, such as that offered by a financial advisor.

Because robo-advice is automated, as opposed to being implemented by a human, the costs and fees are much less which ultimately translates to increased returns for investors in the long run.

So, can a robo-advisor make you money? Sure – but they won’t come without fees.

In fact, fees play a huge part in the decision of investors to either start their investing experience with robo-advisors, or move across from traditional advisors. Here’s a closer look at fees, and whether or not they’re worth it.

If you’re into robo-advisors, you might also like our list of the top stock trading apps on the market.

How Much does a Robo-Advisor Cost?

The price, oh, the price – most people flock towards robo-advisors because of their cool prices. As we’ve mentioned, they cost much less than financial advisors, and although this isn’t the only reason for their success, it is undeniably one of their most appealing features. Fees are still involved however, so just how much does a robo-advisor cost?

Companies typically charge as low as 0.25% up to just 0.50% on the annual management fee, though, if you do your research right you can find a robo-advisors with %0 fees, including Sofi Automated Investing.

Similarly to most financial advisors out there, fees are charged based on a percentage of your assets with a robo-advisor’s service. Clients with $10,000 might be a mere $25 per year. This is the same, if not less than the annual fees charged by banks. Although, the fee is usually divided out and charged as a monthly fee.

Even better than banks and traditional brokers though, you’ll be charged for transaction fees will be no more. If we look at a standard brokerage account, a commission fee may still be charged by some for rebalancing your portfolio, and depositing and withdrawing money, although most are doing away with this recently.  Robo-advisors charge none of these fees. Why would anyone need a Robo-Advisor?

Is a Robo-Advisor Worth It?

We’ve been dancing around the various hybrid robo-advisors. Charles Schwab provides a clear outline of the three types of advisors to help you establish which one best meets your needs; the straightforward, automated robo-advisor; robo-advisory services that are mixed with traditional services; and the standard old traditional services.

Robo and Traditional Advisors Comparison
Understanding the three types of services offered by robo-advisors will help you figure out which robo-advisor can help you achieve your investing goals.

Robo-Advisors

Robo-advisors are best suited to simpler investment goals. They help you stay on track with automated rebalancing of your portfolio. There isn’t usually a financial advisor on offer with robo-advisors, but because of this, you’ll pay low fees in addition to receiving automatic tax-loss harvesting.

Robo + Traditional

This is the hybrid advisor that we’ve been discussing, and is ideal for those who want an automated portfolio built, along with some professional guidance. A robo-advisor plus a traditional advisor will provide access to online planning tools to help you research and strategize.

Conveniently, you’ll also be able to chat with and get advice from an advisor through video calls. These providers will charge moderate fees for the use of a financial advisor.

The OGs: Traditional Advisors

Traditional advisors are the ones we all know, and L-like. In all seriousness though, traditional advisors bring a lot to the table. They offer more complex services like estate planning.

Traditional advisors will help develop a more holistic approach to all your financial accounts. With traditional advisors you will be able to meet in-person with your advisor. As traditional advisors offer more dedicated assistance and complex services they do cost the most out of the three

So, is a robo-advisor worth it? Ultimately, it’s crucial that know what differentiates each one from the other, and know how you can find the best one for you.

There are several aspects to take into consideration when trying to assess both, whether a robo-advisor is right for you, and how to find the best one for you. We recommend you stay on the lookout for these top 4.

1. Account Type

In the majority of cases, robo-advisors manage two account types. That is, individual retirement accounts and taxable accounts. In other cases, you might find some that manage trusts, and in rarer cases, you’ll find robo-advisors that manage your 401(k).

2. Minimum Account Requirements

While most robo-advisors have an account minimum of $500 on average, some have higher account minimums of $10,000. Personal Capital requires an extremely high account minimum of 100,000, and is aimed at very high-net-worth clients. Make sure that the robo-advisors you are considering have a minimum account requirement that you can meet.

3. Recommendations for Your Portfolio

As mentioned above, the sign-up process for robo-advisors usually includes a questionnaire to help determine your goals, financial circumstance, experience and risk tolerance.

Based on these answers, robo-advisors will offer you a couple different portfolio choices, between about five to ten, ranging in risk, from low to more aggressive. Although the algorithm recommends portfolio options based on the questionnaire answers, you can customize them in most cases, or choose something different altogether if you decide.

4. Look at the Investment Selection

Depending on how much portfolio diversity you’re after, some robo-advisors might suit you better than others. In the majority of cases, robo-advisors create portfolios using low-cost ETFs and index funds.

These investments almost fully replicate the movements of indexes, such as the S&P 500. You’ll be charged expense ratios for these funds, which are the fees charged by the funds, in addition to paying a management fee charged by the robo-advisor.

Can a Robo-Advisor Make you Money?

In essence, robo-advisors are made up with the same formula. That is, automated investment management – charging a small fee – so that clients can access trading and tools for less. Here is a broad-stroke look at what you can expect from the best robo-advisors in 2020:

Automatic Rebalancing

Automatic rebalancing will help traders stay on top of their goals. Ultimately, rebalancing is the action of realigning your investments / trading strategy to bring your portfolio back on the right road to help reach your set target desired level of risk.

This is done periodically, for example quarterly, and usually automatically through an algorithm. We can all fall off the bandwagon now and then, or get distracted by trends so, it’s a great way to regain your focus, too, and keep your eyes on the prize.

Financial Planning Tools

Robo-advisors will give you access to financial planning tools, such as retirement calculators.

Wealthfront, for example, offers Path, a tool that helps give you a bigger picture of your finances and whether you are on your way to hitting your retirement goals comfortably. Betterment clients can access financial planners on the firm’s premium plan, and Personal Capital provides access to a financial planner on call.

Tax-loss Harvesting

Tax-loss harvesting is another big one, and if you don’t fully understand the term it is; the action of selling securities that have decreased in value.

Harvesting is similar to realizing that loss, and therefore have the knowledge to offset taxes on both income and gains. The security sold is replaced by one that is similar, and thus maintains a high level of asset allocation and expected returns. Many robo-advisors offer tax-loss harvesting in addition to other features that assist with minimizing tax, including taxable accounts.

For more advanced or complex financial planning, or if you would like the extra security and support that a financial advisor offers, these financial planning services offer robo services coupled with traditional services.

Which Robo-Advisor has the Best Returns?

The companies we’ll mention below not only offer robo-services, but they also provide financial advisors, and fall under the hybrid type we’ve mentioned above. To reiterate, with these providers you’ll receive access to a dedicated financial advisor, but the difference is, instead of meeting in person, you’ll communicate through phone or video chat.

With this model, in most cases, you’ll have the benefits of low fees and human guidance. The more guidance and complexity that is offered, the more you will pay.

So, which robo advisor offers the best ROI, you ask? The right one for you will be very specific to your individual needs, finances, goals and experience.

1. Charles Schwab

Charles Schwab’s Intelligent Portfolios Premium gives clients access to a whole team of financial advisors once you have an account minimum of $25,000 for a $30 per month fees, in addition to a $300 once off planning charge.

2. Vanguard

Vanguard’s Personal Advisor Services also provides access to a team of professional advisors with an account minimum of $50,000 and a charge of 0.30%. This will give you the benefits of your portfolio being managed and guidance, but it won’t afford you the pleasure of having a financial plan customized for you.

3. Personal Capital

Personal Capital will give you dedicated financial advisors, but have a very high account minimum of $100,000 and a charge of 0.89% per year. This robo-advisor hybrid has been chosen as The Tokenist’s top pick for high net-worth-clients.

4. Facet Wealth

Last but not least, with Facet Wealth clients are assigned a dedicated advisor for an annual flat fee of $600, which increased depending on how complex you want your services to be.

This company offers personalized advice, including investment management, and your financial plan will be created for you leaving you with the job of simply implementing it.

These services are a step more personalized, and expensive than pure robo-advisors but it’s all so dependent on what you want and need personally. In other words, your own needs will define the best robo-advisor for you.

What is a Robo-Advisor? (And Should You Be Using One?): A Summary

Robo-advisors have introduced more democratization to the industry, making the world of trading a more accessible one for younger investors by introducing low fees. Not only has this service been popular but it is growing at a rapid pace with projections for 2025 looking to hit a whopping USD 9255.05 billion.

The importance of the human element also must be acknowledged, and has played a key role in the continued success and growth of the robo service. This aspect cannot be minimized.

Beyond being accessible and helping investors get off to a good start, robo-advisors cannot fulfill the crucial role that financial advisors offer. That is why more companies are offering hybrid solutions that combine the best part of the human service with the highlights of robo-capabilities.

Robot-capabilities therefore do and should continue to compliment and drive forward human-advisors, as opposed to eradicating it. This compound introduces a more ‘middle-ground’ when it comes to fees and services, creating a better, more super-human experience for investors.

That said, the services currently offered by robo-advisors should not be underestimated – They are valuable for helping investors both minimize fees, and stay on the right track. Automatic rebalancing, tax-loss harvesting, and financial planning tools will all play an important role in helping investors reach initial and/or simpler financial goals.

Lastly, when considering if a robo-advisor is the best choice for you, be sure to check out our top recommendations, and the unique highlights of each, including Charles Schwab’s Intelligent Portfolios, and Vanguards’ Personal Advisor Service.

Ready to learn about the top factors you need to keep in mind when selecting a robo-advisor? Review our guide on how to choose a robo-advisor for all the latest considerations.

About Author

Tim Fries Tim Fries is the cofounder of The Tokenist. He has a B. Sc. in Mechanical Engineering from the University of Michigan, and an MBA from the University of Chicago Booth School of Business. Tim is also the co-founder of Protective Technologies Capital (protechcap.com).