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Banking Basics

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.

Rachel Velez • January 19, 2022

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

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.

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 efficiently manage and allocate your funds. 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. To help a robo-advisor make ongoing decisions about how to invest your money, you’ll start with either filling out a form or some type of questionnaire about your financial goals.
  2. After depositing  money into your account, the robo-advisor will invest it in options that typically consist of low-cost mutual funds or exchange-traded funds (EFTs) based on your risk tolerance.
  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 help your investment grow over time, consider contributing to your account regularly and on a set schedule.

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:

  • Robo-advisor companies: Companies who primarily offer investment services through algorithms instead of human advisors. Betterment and Wealthfront are examples.
  • Traditional brokers: Brokers that offer traditional investment services as well as robo-advisor products. Examples of this are Charles Schwab, Fidelity, and E*TRADE.
  • Financial technology (fintech) companies: Tech companies that, in addition to offering robo-advisory, also offer an assortment of other financial services and products. One example of this is SoFi.

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 

The majority of robo-advisor services offer individual retirement account and taxable account management. 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

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 usually more affordable than more traditional alternatives, there are still costs associated with opening an account. Find out what the fees might be before you invest with a robo-advisor.

Account minimums

Account minimums, or the minimum amount of money required to get started, can vary by advisors. While some advisors allow you to open an account with barely a minimum, others require 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?

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?

To conduct investment services, all robo-advisors must register with the U.S. Securities and Exchange Commission. Robo-advisors are subject to the same 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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