How Robo-Advisors Will Change the Way You Invest

A robo-advisor is a digital platform offering automated and algorithm-driven investing services. Using an online survey, a typical robo-advisor will ask you about your financial status and long-term objectives. Based on your input, it makes use of data to invest automatically for you.

Wealthfront and Betterment, the original robo-advisors, debuted in 2008. Through an easy-to-use web interface, they wanted to assist investors with managing passive, buy-and-hold investments. Since then, many others have launched robo-advisor services.

Index Funds

With robo-advisors, investors can choose from pre-defined portfolios based on their risk profile. Most robo-advisors use passive indexing techniques, and users aren’t able to buy individual stocks or bonds.

For instance, a robo-advisor might invest in index-based exchange-traded funds (ETF) covering the US stock market, overseas markets, or bond markets.

Unlike mutual funds, ETFs don’t charge sales loads and typically don’t trade securities inside the fund since they’re based on the broad market index.

Rebalancing

Robo-advisors will automatically rebalance your portfolio so it stays in line with your target asset allocation. This also takes the emotion out of investment decision-making.

Tax Efficient

ETFs are generally more tax-efficient than mutual funds. This is because ETFs distribute fewer and smaller capital gains, which means investors have a lower tax liability.

In comparison, traditional actively traded mutual funds produce short-term capital gains that are subject to regular income tax rates.

Tax-loss harvesting is another strategy used by robo-advisors to minimize tax liability. They do this by selling investments with losses to offset any capital gains realized. Robo-advisors automate this process for you, potentially saving you money in taxes.

Lower Fees

Robo-advisors typically charge lower fees than human financial advisors. The fees vary depending on the robo-advisor, but they usually range from 0.25% to 0.89% of assets under management. This is a lot less than the standard fee of 1% (or more for commission-based accounts) that a human financial advisor typically charges.

This means that for a $100,000 portfolio, you would pay between $250 and $890 per year in fees.

Monitoring investments is simple with robo-advisors—you simply log in to your account. And with robo-advisors, you can begin investing with less money than with human advisors.

Are Robo-Advisors Right for You?

If you’re new to investing or don’t have a large amount to invest, the benefit of low management fees combined with no or a low minimum initial account size is a big plus.

It’s also a plus that you can start receiving financial guidance at the outset of your investing career. Typically, that kind of care from traditional financial advisors comes at a higher cost.

Bottom Line

Financial advisors provide advice on investments and other areas of your finances. If you appreciate the personalized advice and guidance that comes with working with a financial advisor, robo-advisors might not be the best fit for you.

Keep in mind that many financial advisors actively manage portfolios to beat the market. However, the fees for their services could potentially offset any extra returns.

Know that robo-advisors seek to match rather than beat the market’s performance. If you’re a novice investor, have a limited investment budget, or lack the time or interest to delve into market complexities, robo-advisors could be an excellent option for you.

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