Considering a Robo-Advisor for Your Investments? What You Need to Know

Computer-driven investment advice, often combined with some level of human support, has become increasingly popular, offering a wide array of options for investors today. Robo-advisors currently manage over $500 billion in investors' assets. If you're considering this approach, here's what you should know:

What is a Robo-Advisor?

Robo-advisors are computer programs that automatically create and manage investment portfolios tailored to your individual financial goals and risk tolerance. Many robo-advisors also offer some access to human financial professionals, often referred to as a hybrid service.

 

Why the Popularity?

One key reason for their success is their ability to help investors avoid emotion-driven investment mistakes. As Bradley Hilton, a certified financial planner, explains, robo-advisors can automatically stay the course and rebalance your portfolio when market fluctuations occur. Research indicates that do-it-yourself investors who switched to low-cost hybrid robo services achieved more diversified portfolios, lower vulnerability to significant losses, and higher risk-adjusted returns. Furthermore, robo-advisor customers have reported gaining an average of six hours a year of free time by spending less time managing their investments.

 

Choosing the Right Robo-Advisor for You

With numerous robo-advisor firms available, it's important to shop for the right service. Consider the level of interaction you desire and whether your financial situation requires specific expertise. Most firms offer both basic automated investment management and hybrid services with human advisors available. If the human touch is important to you, ensure that the plan offers experts who can address your specific questions, whether they are investment advisors or certified financial planners who can assist with broader financial matters like budgeting.

Robo firms are also increasingly offering services tailored to specific investor groups:

• Beginners: Some offer very low or no minimums and educational resources. For example, Fidelity Go is free for portfolios under $25,000. Acorns has plans starting at $3 per month.
• ESG Investors: Several platforms offer portfolios focused on environmental, social, and corporate governance goals, including Acorns, Betterment, Ellevest, and others.
• Overseas Bargain Hunters: Ellevest and Schwab Intelligent Portfolios offer portfolios with a higher allocation to international stocks.
• Investors Seeking Outperformance: Betterment, E*Trade, SoFi, and Vanguard have portfolios aiming to beat market indexes.
• People with Questions: Betterment, Schwab, and Vanguard Personal Advisor offer hybrid clients access to certified financial planners.
• Retirees: Platforms like Betterment, Merrill, Schwab, and Vanguard provide tools for calculating safe withdrawal rates and offer income-focused portfolios. Many also offer "glide path" services that automatically reduce portfolio risk as you approach retirement.
• Set-it-and-Forget-It Types: Acorns, Betterment, Fidelity, and Vanguard offer glide path services.
• Tax Minimizers: Betterment, E*Trade, Merrill, Schwab, Vanguard, and Wealthfront provide automatic tax-loss harvesting, a strategy that can help reduce your tax bill.

 

Understanding the Costs

Be mindful of the costs involved. These typically include:

• Minimum Investment Requirements: These can range from no minimum at some platforms like Betterment, Ellevest, and Fidelity to thousands of dollars for premium services.
• Annual Expense Fees: These cover the management of the underlying exchange-traded funds (ETFs) or mutual funds within the portfolio. Average expense ratios for robo portfolios reviewed range from 0% at Fidelity to 0.17% at Charles Schwab. This compares to an average of 0.15% for exchange-traded index funds.
• Portfolio Management Software and Financial Planner Fees: Most robos charge an additional annual expense fee, generally between 0.15% and 0.45% for basic services and 0.30% to 0.85% for hybrid services. Some firms charge monthly subscription fees ranging from $3 to $30 depending on the service level. Schwab's basic robo service is an exception, charging no management fee but allocating about 10% of each portfolio to a lower-interest money market fund.
• Sign-up Bonuses and Matching Offers: Some firms may offer incentives to reduce fees or boost your initial contributions.

 

Evaluating Portfolio Composition and Performance

Robo portfolios are generally constructed using exchange-traded funds (ETFs), though some may include mutual funds. Comparing returns across different firms can be challenging due to varying algorithms for asset allocation. However, services like Condor Capital Wealth Management track the performance of various robo portfolios. Their analysis of moderate-risk portfolios (around 60% stocks and 40% bonds) showed an average return of 10.1% in 2024 and an annualized average of 6.3% over the five years through 2024. Individual robo-advisors may have significantly different performance based on their specific strategies and asset allocations. Pay attention to whether a robo emphasizes U.S. versus international stocks, cash holdings, and value versus growth stocks, as these factors can impact performance.

 

Key Considerations Before Investing

Before choosing a robo-advisor, consider:

• Your Comfort Level: How much interaction with human advisors do you need?
• Specific Expertise: Does your financial situation require specialized advice?
• Costs: Understand all the fees involved and how they might impact your returns.
• Portfolio Allocation: Does the robo-advisor's investment strategy align with your risk tolerance and goals?
• Available Services: Do you need features like tax-loss harvesting or glide paths?

By carefully evaluating your needs and the offerings of different robo-advisors, you can determine if this increasingly popular investment management approach is the right fit for you. Before that, I suggest to learn the basics in Invest like the BEST.