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What Are Robo-Advisors and How Do They Work?

Using a robo-advisor can be a great way to start investing. Usability, speed, and automation are just some of the ways robo-advisors are revolutionizing investment management.

Katana Dumont • January 19, 2022

Technology is an intrinsic part of our lives, and new technological advances are making it easier and more efficient to plan our finances and meet our financial goals. One leading example of this is robo-investing servicers, known as robo-advisors.

Since their introduction nearly a decade ago, robo-advisors have been bringing investment services to a wider audience with over 100 options now available. According to Insider Intelligence, robo-advisors saw a surge in account openings since 2020 (up 23.2%), putting usage on track to surpass 5 million users by 2025.

Let’s take a look at how robo-advisors work and how they can be a great investment resource for you.

In This Article

  1. What Is a Robo-Advisor?
  2. How Do Robo-Advisors Work?
  3. Types of Robo-Investing
  4. What to Look For in the Best Robo-Advisors
  5. Are Robo-Advisors Worth It?
  6. FAQs
  7. Final Thoughts

What Is a Robo-Advisor?

Robo-advisors are software products that use algorithms to automate and build an investment portfolio for clients. Robo-advisors provide an alternative way to invest without relying on traditional, human financial advisors — often at a fraction of the cost.

They use their algorithms to manage and allocate your assets in the most efficient way possible, allowing you to be hands-off with your investments. Robo-advisors offer an array of services, from risk tolerance assessment to portfolio management. 

How Do Robo-Advisors Work?

Each robo-advisor service is different, and the exact procedures might differ, but in general, here are how robo-advisors work and how you can get started with one:

  1. When you open an account with a robo-advisor, you will start by answering some general questions concerning your risk tolerance, your investment goals, your investment timeline, etc. This is how the robo-advisor will make ongoing decisions about how to invest your money.
  2. You’ll then deposit money into your account, and the robo-advisor will invest it in diversified portfolios of stocks and bonds that match your risk tolerance. These will typically consist of low-cost mutual funds or exchange-traded funds (ETFs). 
  3. After your account is funded, the robo-advisor will regularly monitor market activity and your investments to ensure your portfolio is rebalanced appropriately. 
  4. To get the most out of your robo-advisor account, you’ll want to contribute on a weekly or monthly basis. This will help your investment grow in the long term.

What’s an EFT?

An exchange-traded fund is a type of security containing many types of investments such as stocks, bonds, and gold. EFTs can be bought and sold on a stock exchange.

Types of Robo-Investing

There are a ton of robo-investing services available to consumers with the general aim being the same — to provide financial advice or manage investments using automated technology. That being said, you can generally classify robo-investing services into 3 definite categories:

  • Traditional brokers: Brokers that offer traditional investment services, like the ability to buy stocks and mutual funds, but also offer robo-advisor products for customers who want to automate. Examples of this are Charles Schwab, Fidelity, and E*TRADE.
  • Robo-advisor companies: Companies that were created for the primary purpose of automating the investing process through algorithms instead of human advisors. Betterment and Wealthfront are examples.
  • Financial technology (fintech) companies: Tech-focused companies that offer a range of financial products, including robo-advisory services. SoFi is one example of this.

What to Look For in the Best Robo-Advisors

Are you thinking about opening an account with a robo-advisor? If so, it’s important to know what to look for and what things to consider in order to choose the best robo-advising service for you.

Take into account the following:

Account Offerings 

Most robo-advisors manage both individual retirement accounts and taxable accounts. But few manage trusts and 401(k) accounts. Decide what type of account management is important to you and choose the robo-advisor that can meet those needs.

Features

Keep an eye out for additional features offered beyond the basic portfolio management. Features to look for include: automatic daily rebalancing of your portfolio, tax-loss harvesting, which can help you save on taxes with an individual or joint account, and financial planning tools, such as retirement calculators.

Fees 

Consider the costs of opening an account. Although robo-advisors are generally far cheaper than their human counterparts, there are still costs associated with opening an account. Find out what the annual management fee you’ll be charged is, as well as the fees associated with the ETFs that will comprise your portfolio.

Account Minimums

Account minimums, or the minimum amount of money required to get started, can vary drastically between advisors and range from nothing to tens of thousands of dollars. Shop around for advisors that either have very low or no minimums at all. In some cases, you can even get started investing with $1.

Customer Support

Some robo-advisors give you the option of speaking with a human financial advisor for help when something goes wrong or you have a complex question about your account. Look for robo-advising services with 24/7 customer support or the option to talk to a live person.

Are Robo-Advisors Worth It?

Depending on your situation, financial standing, and goals, opening an account with a robo-advisor can be worthwhile. Robo-advisors can benefit a range of investors, from novice investors, who want to learn how investing works, to seasoned ones, who want a hands-off way to manage their investment portfolios.  

Here are some reasons why a robo-advisor might be the right investment move for you:

  • Doesn’t take a lot of time to setup and start investing
  • Presents an alternative to using a human advisor at a lower cost
  • Provides a more accessible way to invest that’s available 24/7
  • Offers a way to invest that is hands off and allows you to manage your money with a professional investor
  • Great introduction to investing for new investors who want to start investing at a slower pace

FAQs

How much does a robo-advisor cost?

Robo-advisor fees and costs can vary. Fees may be structured as a fixed monthly fee, or fees can be structured as a percentage of assets. Fixed monthly fees can be as low as $1. Most percentage fees range from roughly 0.25% to 0.50%.

Are robo-advisors safe?

As with any investment service, investments offered through a robo-advisor can be risky. The riskiness of a portfolio will depend on you as an investor and what you are willing to wager. Keep in mind that using a robo-advisor might actually be a safer alternative to investing in stocks and bonds on your own, especially for beginners.

How are robo-advisors regulated?

All robo-advising services must register with the U.S. Securities and Exchange Commission to conduct business and are therefore subject to the same securities laws and regulations as traditional brokers. 

Final Thoughts

It’s a safe prediction to say that robo-advisors will only continue to grow from here, becoming a leading force in investments and money management services. It’s never too early to start financial planning for your future, and robo-advisors can be an advantageous way to get started. 

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