Takeaways
- Robo-advisors offer automated investment services and online platforms.
- Robo-advisors use complex algorithms to automatically manage investments.
- Robo-advisors are popular among beginner investors avoiding high fees.
- Robo-advisors have benefits like automatic rebalancing and tax loss harvesting.
- Investment firms like Blackrock, Vanguard, and Schwab have robo-advisor platforms.
You might have heard the term “robo-advisor” used in conversations about the stock market, investing, or retirement planning. Robo-advisors made a splash in the investing world in 2008 with the launch of two major robo-advisor players, Betterment and Wealthfront. [1,2]
There has been an explosion in robo-advisor offerings since their original debut. Major investment firms like Vanguard, Charles Schwab, and others have also gotten into the game, managing billions of dollars in investment capital. [3]
What drew in these funds? Robo-advisors have become the investment platform of choice for many younger or beginner investors who want investment advice without sitting down and talking to a financial advisor. Let’s dive into what exactly a robo-advisor does.
What Is a Robo-Advisor?
A robo-advisor is an automated financial planning and investment advisory platform. These platforms provide these automated services with little to no human interaction. To do this, robo-advisors use complex algorithms, simulators, and cutting-edge technology to create and manage investment portfolios based on customer preferences. These digital platforms analyze financial goals, risk tolerance, and personal investment preferences and manage long-term investments. [4]
To use a robo-advisor, you usually start by filling out an online questionnaire that sources information about your financial situation, investment goals, level of discretionary income, retirement goals, and desired level of investment risk. This data collection phase assists the robo-advisor in generating a curated and diversified portfolio based on your prespecified preferences.
Automated investment advisors provide an array of offerings, like investor education, account management, return simulations, and portfolio optimization. In general, robo-advisors create portfolios of low-cost exchange-traded funds, mutual funds, target date funds, and other “basket-type” approaches to investing in the stock market. Some platforms automatically manage your portfolio and recommend adjusting your holding to meet your goals.
Their convenience and low-cost investing approach have made robo-advisors extremely popular, especially among younger investors. Millennial and Gen Z investors have leaned into the robo-advisor space because these platforms let them begin investing immediately and track their investment holdings in a one-stop shop. For investors who want a hands-off but managed approach to investing, robo-advisors have become the preferred solution.
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Advantages of Robo-Advisors
Robo-advisors are tremendously powerful investment machines that offer several advantages to experienced and beginner investors. These platforms leverage technology to make the investment and financial planning process simple and streamlined. Here are several benefits for you to consider:
Automatic Rebalancing
A significant benefit of using a robo-advisor is rebalancing your portfolio automatically. Over time, your investments cause your asset allocation percentages to shift dynamically. For example, suppose you want to maintain 60% of your portfolio in stocks but have a high-performing portfolio that increases your stock position to 80% of your holding (due to significant investment gains). In that case, your robo-advisor can automatically shift your asset mix back into balance by prompting you to liquidate some of your gains.
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Your robo-advisor continuously monitors your asset mix and makes the necessary changes to return it to the desired allocation. Automatic rebalancing means you will not have to worry about losing track of your allocation mix; your robo-advisor will handle it without intervention. This saves you time, money, and effort. For investors who are busy and on the go, this can make investing in robo-advisors even more attractive.
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Tax Loss Harvesting
Harvesting tax losses is another incredible benefit offered by robo-advisor platforms. Tax loss harvesting is a tax strategy that sells poor-performing securities at a loss to offset your investment gains made elsewhere in your portfolio. This has the overall effect of lowering your total tax liability. The proceeds from the sale are then used to obtain similar securities to keep the portfolio’s allocation and performance profile the same.
Robo-advisors can use complex algorithms, artificial intelligence, and machine learning to identify the best opportunities for tax loss harvesting. Leveraging this technology allows robo-advisors to execute loss harvesting for portfolio optimization consistently. By enabling the robo-advisor to automate this strategy, you maximize post-tax returns without requiring active management or a deep understanding of how the Internal Revenue Service treats investment-related taxes.
Investors in higher tax brackets can significantly benefit from tax loss harvesting. It can lead to massive tax savings, which can be reinvested into a better-performing stock to continue growing the portfolio. Automatically reinvesting can add even more value to the platform’s functionality.
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Lower Costs
One of the most appealing aspects of using a robo-advisor is its lower cost structure than traditional financial advisors. Robo-advisors usually charge only a fraction of the fees associated with using human advisors. They can charge less because they rely on powerful technology to automate management tasks, reducing the need for human intervention and management fees.
Financial advisors and robo-advisors have a similar fee structure based on assets under management (AUM). However, they vary in how much they charge. With a human financial advisor, fee schedules usually start at 1% of AUM and increase. These fees can quickly become inflated with additional services. Compare this to the fees charged by robo-advisor platforms, which are often between 0.25% and 0.50% of AUM. When paid over the portfolio's lifetime, the savings in fees alone can be massive.[5]
Robo-advisors tend to invest in low-cost, managed funds. Building portfolios primarily around ETFs and mutual funds can lower the expense ratio even more. Cost efficiencies like these make robo-advisors an extremely attractive option for younger investors who want to minimize fees and maximize returns.
Disadvantages of Robo-Advisors
While robo-advisors are loaded with benefits, they also come with some disadvantages. If you are considering using a robo-advisor platform to automate your portfolio management, remember there are potential drawbacks. Here are several to contemplate:
Curated Investment Options
Robo-advisors generally offer a limited curation of investment options. These are often predefined sets of low-cost exchange-traded funds and similar investment vehicles. This approach can be efficient and cost-effective, but it likely will not address the needs of investors looking for more diverse strategizing.
For example, if you like picking individual stocks or trading stocks, a robo-advisor might not be your best solution. Instead, a financial advisor could help you comb through the highest-performing stocks to make suggestions and recommendations. You can also do this through an online stock brokerage account.
One-Size Fits All Approach
Another massive drawback to the robo-advisor model is the one-size-fits-all approach to their investment solutions suite. There is limited flexibility when customizing your investment approach, particularly if you have unconventional goals.
For example, an algorithm may only partially account for unique circumstances such as irregular freelancer income, specific tax needs, or the handling of complex estates. Also, the lack of individualized advice could mean you are not getting the proper planning or portfolio optimization.
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Lack of Personal Touch
Another disadvantage of using a robo-advisor is the need for more human attention (although some hybrid models help alleviate this downside). This lack of human engagement can be a substantial drawback if you are looking for a face-to-face relationship, have specific questions, or the platform needs to consider your investments outside of the platform.
A financial advisor can provide a level of empathy and understanding that the most complex algorithms cannot replace. Finance experts often say that personal finance is about managing emotions and habits as much as about having the education to make intelligent investment choices. Financial advisors can provide emotional support during market volatility and suggest guidance based on their knowledge of their clients.
Robo-Advisors vs. Financial Advisors
Deciding between using a robo-advisor and a traditional financial advisor often comes down to how much personal attention you want on your finances (and whether you want to pay for it). Robo-advisors can be smart choices for investors who want to take advantage of the Do-It-Yourself investing approach with the backing of sophisticated automation, algorithm-driven management and performance, and lower cost structures.
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Alternatively, a financial advisor could be better if you like a more personal touch. With a traditional advisor, you will get personalized and comprehensive portfolio management and additional financial planning services. This more customized service comes at a higher cost and extra fees, but that might be worth it. A wise policy is to meet with many financial advisors to see who you mesh with because getting along with your financial advisor and trusting their recommendations will add to the health and depth of your working relationship.
Smart Summary
Choosing where to invest your hard-earned money can take time and effort. The entire robo-advisor industry has worked to make the process easier, more accessible, and highly digestible to millions of new investors. Robo-advisors now manage billions of dollars of investment capital. Boost your net worth by taking advantage of the powerful technology, low fees, and curated investment solutions offered by these platforms. Explore the top platforms, like Acorns, to see if they are right for you.
(1) Reuters. Roboadvisor Wealthfront reaches 50 billion in client assets. Last Accessed January 15, 2025.
(2) Betterment. Jon Stein. Last Accessed January 15, 2025.
(3) Investing in the Web. The Largest Rob Advisors by AUM. Last Accessed January 15, 2025.
(4) U.S. Securities and Exchange Commission. Robo-Advisor. Last Accessed January 15, 2025.
(5) U.S. Securities and Exchange Commission. Updated Investor Bulletin: How Fees and Expenses Affect Your Investment Portfolio. Last Accessed January 15, 2025.
