What Is a Robo-Advisor?

A robo-advisor is an investment manager that uses computer algorithms to create the best mix of stock, bond, and other types of financial assets based on the client’s preferences. The goal is to give you the best returns for your specific risk level.

Robo-advisors emerged in the wake of the 2008 financial crisis and were created to give individuals access to investment management for lower fees and lower investment minimums than those available from a traditional financial advisor.

The earliest robo-advisors were Betterment, Wealthfront, and Personal Capital. 

There are currently scores of robo-advisors in the United States and across the globe with a few commonalities and many more distinctions.

What Robo-Advisors Have in Common

The main commonality among robo-advisors is that they enlist computers to create their investment portfolios. 

These groups of investments are crafted based on the investing best practices and Modern Portfolio Theory. Modern Portfolio Theory is a theory developed by Harry Markowitz on how to maximize the returns of a portfolio based on a level of risk.

All robo-advisors enlist computers to create the investment portfolio. The user answers several questions about his or her goals, investing timeline, risk tolerance, and other personal preferences. The computer program then uses the responses to create the investment mix or asset allocation that best captures the user’s goals and risk level.

In most, if not all cases, the investor may change the asset allocation to reflect a preference for a more conservative or more aggressive asset mix.

Most investment portfolios are created with low fee exchange-traded funds (ETFs). A majority offer stock and bond ETFs representing the domestic and global markets.

Rebalancing is another core robo-advisor feature. That means that when the asset class (like stocks or bonds) deviates from the desired percentages, the robo-advisor will buy or sell funds and return the portfolio to the preferred asset allocation.

That’s where the similarities among robo-advisors ends.

Where Robo-Advisors Differ

There are more differences than similarities among robo-advisors. Here are the features that distinguish robo-advisors:

  • Fees-Robo-advisor management fees range from zero to approximately 0.90%.
  • Investment minimums-Minimum investment amounts range from zero to $100,000.
  • Live financial advisor access-Ranges from no financial advisor access to live advice for all clients.
  • Tax-loss harvesting-Helps to reduce taxes by selling securities incurring a loss to offset the gains from another security. The frequency ranges from none to daily.
  • Asset Classes-This is one of the greatest differentiators among robo-advisors. One robo-advisor may offer four ETFs while others offer scores of funds and even individual stocks. The asset class selections span stocks, bonds, real estate, commodities, and more.

Pros and Cons of Investing with a Robo-Advisor

Pros

Robo-advisors offer professional investment management with lower fees than most financial advisors.

There is a wide variety of types of services, investment portfolios, and features, offering investment management for a range of investors.  

Robo-advisors are based on sound investing theory and in most cases are expected to offer returns in line with their underlying asset classes. Research has shown that market matching performance in most cases is better than active management.

There are also robo-advisors available for investors interested in actively managed portfolios. 

Cons

Customer service may be lacking.

In most cases, investors can’t fully customize their investments and must be content with pre-made investment portfolios.

Most robo-advisors lack access to tax, estate, and other financially related services. 

There may be less certainty with the robo-advisor concept. Robo-advisors are newer investment management platforms with shorter operating periods. Quite a few robo-advisors have failed while others have become more widely adopted. Overall, the usage of robo-advisors is on the rise. 

Key Robo-Advisor Takeaways

Robo-advisors are unique.

Beginner to advanced investors can benefit from investing with a robo-advisor.

Hybrid robo-advisors combining human and digital advice are increasing in frequency and popularity. 

Robo-advisors are available at prominent financial firms like Schwab and Fidelity as well as at stand-alone firms like SigFig and Betterment.

Digital investment management is democratizing investing allowing all levels of investors to benefit from professionally managed portfolios. 

FAQs

A robo-advisor is an investment manager that uses computer algorithms to create the best mix of stock, bond, and other types of financial assets for you. The goal is to give you the best returns for your specific risk level.
The main commonality among robo-advisors is that they enlist computers to create their investment portfolios. These groups of investments are crafted based on the investing best practices and Modern Portfolio Theory. Most investment portfolios are created with low fee exchange-traded funds (ETFs). A large majority offer stock and fixed or bond ETFs representing the domestic and global markets. Rebalancing is another core robo-advisor feature. That means that when the asset class (like stocks or bonds) deviates from the desired percentages, the robo-advisor will buy or sell funds and return the portfolio to the preferred asset allocation.
All robo-advisors enlist computers to create the investment portfolio. The user answers several questions about his or her goals, investing timeline, risk tolerance, and other personal preferences. The computer program then uses the responses to create the investment mix or asset allocation, that best captures the user’s goals and risk level.
Fees-Robo-advisor management fees range from zero to approximately 0.90%. Investment minimums-Minimum investment amounts range from zero to $100,000. Live financial advisor access-Ranges from no financial advisor access to live advice for all clients. Tax-loss harvesting-Helps to reduce taxes. The frequency ranges from none to daily. Asset Classes-This is one of the greatest differentiators among robo-advisors. One robo-advisor offers four ETFs while others offer scores of funds and even individual stocks. The asset class selections span stocks, bonds, real estate, commodities, and more.
Robo-advisors offer professional investment management with lower fees than most financial advisors. There is a wide variety of types of services, investment portfolios, and features, offering investment management for a range of investors. Robo-advisors are based on sound investing theory and in most cases are expected to offer returns in line with their underlying asset classes. Research has shown that market matching performance in most cases is better than active management.

True Tamplin, BSc, CEPF®

About the Author
True Tamplin, BSc, CEPF®

True Tamplin is a published author, public speaker, CEO of UpDigital, and founder of Finance Strategists.

True is a Certified Educator in Personal Finance (CEPF®), a member of the Society for Advancing Business Editing and Writing, contributes to his financial education site, Finance Strategists, and has spoken to various financial communities such as the CFA Institute, as well as university students like his Alma mater, Biola University, where he received a bachelor of science in business and data analytics.

To learn more about True, visit his personal website, view his author profile on Amazon, or check out his speaker profile on the CFA Institute website.