What Is a Robo-Advisor? A Simple Explanation (2024)

For many people, figuring out how to invest money can be confusing. Traditionally, those who didn't want to take the time to determine how best to put their money into the market would have to pay for a financial advisor or dedicated investment advisor. Often this was prohibitively expensive, especially for people just getting started.

Robo-advisors changed all that. They allow you to easily invest, even if you don't have a lot of money, because the process is automated. Instead of a traditional advisor picking your investments, watching over them, and moving your money as needed, algorithms do the legwork.

The idea of investing with a robo-advisor is attractive for many. You don't have to do much beyond answer a few simple questions, and your money is invested in a way that's aimed at accomplishing your goals. But although this method of investing can be a great one under the right circ*mstance, it's not right for everyone. If you're wondering exactly what a robo-advisor is and whether this is the right option for you, this guide will help you figure that out.

What is a robo-advisor?

A robo-advisor is an online financial management firm that relies on algorithms to determine how best to allocate customers' investment dollars.

Because no human intervention is required to pick investments or rebalance portfolios, robo-advisors can be an affordable solution. If you don't want to have to research investment options or ensure you're maintaining an appropriate asset allocation, a robo-advisor could be a good option.

Robo-advisor services are an alternative to both traditional investment advisors and discount brokers. You can open an account with one, often with a low- or no-minimum investment, answer a few simple questions about your goals, and your money will be put into an appropriate mix of investments for a very reasonable management fee.

How do robo-advisors work?

Robo-advisors use algorithms to make sure your mix of investments is well-aligned to your financial goals.

When you sign up for a robo-advisor, you'll be asked a series of questions about your investment strategy, your timeline for needing the money, your goals for growing wealth, and your risk tolerance. The robo-advisor will then recommend a diversified portfolio of investments suited to your needs. Depending on the robo-advisor, you may be able to make some tweaks to its suggested portfolio or simply accept as is.

Once your money is invested, most robo-advisors offer automatic rebalancing, which lets you maintain an appropriate mix of different assets well-suited to your risk tolerance and your investing timeline. For example, if one of your investments grows much faster than the others, you could end up too heavily concentrated in that particular asset. The robo-advisor will fix that for you by spreading some of the money around so your portfolio gets back to balanced.

Some robo-advisors also employ strategies to help you keep taxes down on your investments, including tax-loss harvesting, which involves selling losing investments to offset gains you'd otherwise be taxed on.

Robo-advisor pros and cons

There are both advantages and disadvantages to using a robo-advisor to invest your money. You'll need to weigh both to decide whether you like this approach to getting your money into the market.

Advantages of robo-advisors

The biggest benefits of robo-advisors include the following:

• Robo-advisors come with low fees. Although traditional financial advisors often charge upward of 1%, especially for smaller accounts, most robo-advisors charge a flat fee, typically below .5%, of your total account balance.
• Robo-advisors make investing easy. You don't need to know a lot about picking stocks or portfolio balancing to get started — you just need to be able to answer a few basic questions.
• Robo-advisors enable hands-off investing. You don't have to worry about rebalancing your portfolio as your investment balance changes — the algorithm does it for you.
• Robo-advisors have low account minimums. Most enable you to start with a small minimum balance or no minimum balance at all. You can invest with less money than traditional investment advisors would require. Plus, you can build a diversified portfolio at a relatively low cost.
• Robo-advisors enable you to take advantage of sophisticated investing strategies. For example, many offer tax-loss harvesting, either with all accounts or as a premium feature.

Disadvantages of robo-advisors

There are, however, also some downsides to robo-advisors, including the following:

• You have to pay a fee. Although robo-advisors aren't as expensive as traditional financial advisors, you are still paying a fee. If you manage your investments without this help, you could avoid the costs associated with paying for investment assistance.
• You have to give up control. You don't get to pick stocks, bonds, ETFs, or mutual funds you want to buy. Although this is a good thing for many people, as it's difficult for ordinary investors to successfully beat the market, you are still giving up the opportunity to take a more hands-on approach.
• Not every brokerage offers a robo-advisor. You're more limited in whom you invest with as not all major brokers offer robo-advisory services.
• You won't get much personalized financial advice. Although a human financial advisor listens to you, answers questions, and works with you, most robo-advisors provide limited human interaction or personalized guidance.

4 popular robo-advisors and their features

• Betterment
• Wealthsimple
• Wealthfront
• Blooom

Betterment

Betterment offers two different options for those looking to use its robo-advising service: a digital plan with no minimum balance required, and a premium plan available to investors with $100,000 or more.

Both the digital and premium plans are available for taxable brokerage accounts; SEP, Roth, Traditional IRAs, and 401(k) retirement accounts; and account rollovers. And both plans build you a diversified portfolio of ETFs made up of U.S. and international stocks and bonds.

Betterment's Digital Plan charges an affordable management fee of just .25% per year, whereas the Premium Plan comes at a cost of .40% annually but offers unique features including the ability to talk with a certified financial planner or other licensed financial expert at any time. Both the Digital and Premium Plans also offer attractive features including automatic portfolio rebalancing and tax-loss harvesting to minimize the taxable consequences of your investments.

Wealthsimple

Wealthsimple also allows you to get started with no minimum balance, but fees decline if you have more invested. Those with $0 to $100,000 deposited with Wealthfront will pay .5% in fees; investors with more than $100,000 get a discounted rate of .4%.

Once you've signed up, Wealthsimple will invest your money in at least six to seven different ETFs, each of which give you exposure to a different asset class. This enables you to effortlessly diversify your portfolio. Wealthsimple also provides tax-loss harvesting, customizes your portfolio based on your financial goals, and automatically reinvests dividends for you.

If you're looking for in-person support, Wealthsimple is unique in that customers can talk with a financial expert about their investments, while Betterment offers this type of personalized advice only with premium accounts. Wealthfront also offers Socially Responsible Investments so you can opt to invest in companies that align with your values.

Wealthfront

Unlike several of the other robo-advisors on this list, Wealthfront requires a $500 investment minimum. Once invested, your money will be invested in a mix of ETFs that give you exposure to 11 global asset classes. Like other robo-advisors, Wealthfront will ask you about your goals and put together a personalized portfolio appropriate to meet your needs.

Wealthfront offers features to help you invest wisely, including automatic portfolio rebalancing and tax-loss harvesting. You can also access free financial planning services, which provides insight not only into investment decisions, but also other important choices that affect your money. For instance, it can help you determine whether to buy a home or how paying for college for your children could affect your retirement.

Blooom

Blooom is a unique robo-advisor because it is catered towards employer-provided plans. In fact, you can only use Blooom to invest funds in a 401(k); 457; 403(b); 401(a) or TSP Plan. Blooom has no minimum balance requirements, but you will pay a $10 monthly fee for management services. The good news is, that fee is the same no matter how large your account. Therefore, this can be a great option if you have significant assets to invest for employees.

Blooom is a registered investment advisor. Its automated algorithm puts together a mix of appropriate investments for you, with options coming from more than 14 different categories of assets including large cap, small cap, mid cap, emerging markets, and international funds. The goal when selecting investments is to give you an appropriate asset allocation while getting the lowest internal expense ratio.

Blooom relies on both human advisors and its customized algorithm to help make it easy for employers to offer workplace retirement plans. Every 90 days, it also checks your portfolio to make sure it's balanced. It also automatically rebalances it as needed to ensure your portfolio maintains the right mix based on your needs.

FAQs about robo-advisors

The bottom line on robo-advisors

Robo-advisors can be a much more affordable solution to wealth management for people who want help investing in a diversified mix of different assets. You can choose from several robo-advisors and each offers its own unique perks, including access to human financial help or tax-efficient investing. If you don't mind paying a small fee for hands-off investment management, check out our picks for the best robo-advisors to find the right option for you.

FinanceBuzz is not an investment advisor. This content is for informational purposes only, you should not construe any such information as legal, tax, investment, financial, or other advice.