Are Robo Advisors Worth It?

When robo advisors first began popping up a little over a decade ago, there were plenty of skeptics. But robo advisors have since gone mainstream, so much so that nearly every major investment brokerage firm now has its own robo platform.

Robo advisors are automated investment platforms that provide comprehensive investment management at a low annual fee. The biggest advantage is investors in all portfolio sizes can get the benefit of a fully diversified investment portfolio even with no knowledge or experience of how investing works.

That makes robo advisors the perfect choice for new and small investors who are looking to get started, but lack the time and knowledge to do it on their own.

Meanwhile, as the field of the best robo advisors has grown, so have the services they offer. Many have moved beyond basic investing and have added other financial services. That even includes live financial advice on a small number of platforms. Robo advisors can be a good investment choice even for investors with larger portfolios.

The Biggest Advantages Robo Advisors Provide

Robo advisors make investing less complicated, so people can get started rather than being overwhelmed and possibly never investing at all.

But let’s break down the many other advantages robo advisors provide.

1. Low minimum initial investment requirement

Since robo advisors are designed specifically for small and new investors, they usually have very low initial investment requirements. While there are a few that require at least a few thousand dollars to get started, others will enable you to invest with as little as $100. Still others require no funds at all to open an account, though you will need to deposit money to begin investing.

2. A balanced portfolio created for you

Robo advisors don’t simply open an account and load it up with investments. Instead, they create a portfolio that includes equities, bonds, and even alternative investments, like real estate.

They also invest your portfolio in foreign stocks and bonds to give your portfolio international exposure. Still others invest in very specific market sectors, like value stocks.

You don’t need to know (or do) anything about portfolio diversification. Robo advisors take care of that for you.

3. A portfolio designed to match your investor profile

Most robo advisors will require you to complete a questionnaire when you sign up for the service. The questionnaire will have questions designed specifically to determine your investment goals, your time horizon, and your risk tolerance. Your portfolio will be constructed based on your answers on the questionnaire.

For example, if the questionnaire reveals you have a more aggressive investment profile, your portfolio will be invested primarily in stocks. But if you’re determined to be on the conservative side of the ledger, a larger position in bonds will be included.

4. Comprehensive investment management

This benefit is really what robo advisors are all about. They handle all the details of investment management. That includes periodically rebalancing your portfolio to remain consistent with your target allocations, and reinvesting dividends. Many also provide tax-loss harvesting in taxable investment accounts, to minimize capital gains tax.

There’s no need on your part to do any research, track your positions, or buy and sell securities. The advisor does it all for you, automatically.

5. Low fees

Robo advisors provide comprehensive, automated investment management for incredibly low fees.

Most charge an annual advisory fee, which typically ranges between 0.25% and 0.50% of your portfolio value. For example, a $10,000 portfolio can be managed for just $25 per year if the annual advisory fee is 0.25%.

That compares favorably with the typical range of 1.0% to 1.5% usually charged by traditional, human financial advisors.

Some robo advisors charge higher fees, but others have no fee at all.

6. Low-cost investment expenses

Robo advisors specialize in the use of low-cost investments. To do this, they invest primarily using index-based exchange traded funds (ETFs).

This is an important strategy for two reasons. First, unlike mutual funds, ETFs don’t charge load fees. These are sales charges by mutual funds that can range between 1% and 3% of the value of a fund.

The second is low expense ratios. These are fees charged for the management and marketing of a fund. Since the ETFs used by robo advisors are index-based, they don’t trade frequently the way actively traded mutual funds do. This greatly lowers transaction costs and other expenses.

While a typical actively traded mutual fund might have an expense ratio of 0.50%, an index-based ETF used by a robo-advisor may be at only 0.10%.

The difference of 0.40% in the expense ratio – which is charged annually – makes a significant difference in the future value of your portfolio, especially over many years.

7. A taxable investment account and an IRA with the same platform

Most robo advisors can accommodate both taxable investment accounts and IRAs. There’s no need to maintain accounts with separate investment platforms.

8. Your portfolio tracks on your smartphone

Given the tech orientation of robo advisors, it’s no surprise most offer mobile app access. This will give you the ability to track your portfolio on a continuous basis, and even to fund your account on the go.

9. Convenient account funding

Funding a robo-advisor account couldn’t be easier. You can link an external bank account to transfer funds to the robo-advisor account. Most will even let you set up recurring deposits, drawn either from your bank account or from your paycheck.

10. The robo advisor handles your investments – you’re then free to get on with the rest of your life

This is the ultimate advantage robo advisors provide. Even if you know nothing about investing, using a robo advisor makes the process as easy as it can be.

The robo advisor will provide complete investment management, and your only responsibility will be to fund your account. Since you can do that automatically, both the management and funding of your account can happen without any effort on your part.

Still deciding? Check out Robo Advisors vs Financial Advisors: Which One Is Right for Me?

Extra Features That Can Come with Robo Advisors

When robo advisors came on the scene barely a decade ago, they were pretty basic products. You funded your account, the robo advisor provided automated investment management, and that was about all they did.

In an effort to attract a larger client base, many robo advisors have been incorporating additional services.

For example:

Help Accumulating the Funds to Invest

Though there are other robo advisors that offer help with accumulating funds to invest, probably no other platform has had a bigger impact in this area than Acorns.

It’s a robo advisor to be sure, but perhaps its biggest standout feature is its “Round Ups.”

You connect the Acorns app with a spending account, like your checking account. Each time you make a purchase using an attached debit card Acorns will round it up. For example, a purchase of $6.25 is rounded up, and your account is charged $7. The additional $0.75 is held and eventually transferred into your Acorns investment account.

In this way, you can accumulate funds to invest through regular spending activity. Since the roundups are less than a dollar (though you can set a higher limit), you’ll hardly notice the money leaving your checking account.

Once the funds are transferred into your Acorns investment account, they’ll be fully managed, robo-advisor style.

Banking Services

Many robo advisors are now expanding to offer banking services. For example, both Betterment and Wealthfront offer interest-bearing cash accounts. Those accounts come with checking privileges, debit cards and check deposits.

Wealthfront also adds a portfolio line of credit. You can borrow up to 35% of the value of your taxable investment account (with a minimum balance of $25,000) at a very low interest rate, and without the need for credit approval.

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Self-Directed Investing

Some robo advisors are part of larger investment concerns that offer self-directed investing. You can maintain part of your portfolio in their robo-advisor platform, while trading through a self-directed account with the same firm.

One popular example is Vanguard Digital Advisor. It’s a robo-advisor service, but since it’s part of the Vanguard family, you can also engage in self-directed investing. First and foremost, this includes investing in mutual funds and ETFs of your choice, but also trading in stocks and other securities.

Fidelity and Charles Schwab are two additional examples. As the two largest retail brokerage firms in the U.S., each not only offers complete self-directed investing, but also a robo advisor option.

Want a closer look? Check out Schwab Intelligent Portfolios vs Vanguard: Which Robo Advisor Should You Pick?

You Build Your Own Portfolio – They Manage it For You

Though robo advisors are not known for allowing investors to choose their own investments, there are some notable exceptions.

Perhaps the biggest exception is M1 Finance, using an investment method referred to as “Pies”. Each Pie can be filled with up to 100 “slices,” which can be either individual stocks or ETFs. You can choose from thousands of securities and build a Pie anyway you like. You can also create an unlimited number of Pies within your account.

But once you’ve created one or more Pies, M1 Finance will manage each Pie for you. That will include periodic rebalancing and reinvestment of dividends.

Access to Financial Services

SoFi is yet another example of a hybrid investment platform. You can take advantage of the SoFi Automated Investing robo advisor, but also participate in self-directed investing in stocks, ETFs, and even cryptocurrency.

In addition to investment services, it also provides a wide variety of loan products. This includes student loan refinancing, home loans, personal loans, credit cards, and auto loan refinancing.

Still want some human help? SoFi Automated Investing Gives You Access to Financial Advisors

Employer Sponsored Retirement Plan Management

One robo advisor is even pioneering the way into managing employer-sponsored retirement plans. Robo advisors have traditionally avoided this market because of the qualified nature of these plans.

But a robo advisor called blooom can provide management of 401(k), 403(b), 457 and TSP plans for a low flat fee. You don’t even need to get the permission of your employer or of your plan trustee to use the service.

Managing employer-sponsored plans is nothing less than revolutionary. Most investors are on their own when it comes to managing these plans. But a service like blooom – and we can assume others will follow – can provide complete management of what is for many people their single biggest investment.

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Comprehensive Wealth Management

This service is practically a contradiction in terms. After all, the most basic concept guiding robo advisors is automation, right?

Not any longer. Some platforms are moving into comprehensive wealth management that may include a robo-advisor format.

One prime example is Personal Capital. It’s not technically a robo advisor, but more of a hybrid wealth management service that uses a similar methodology. It offers comprehensive wealth management for investors with portfolios of at least $100,000.

That also extends to direct contact with a financial advisor. It’s even possible to get a customized portfolio of individual stocks, bonds, ETFs and cash equivalents. Personal Capital doesn’t manage employer-sponsored retirement plans, but it can provide management advice for these accounts.

Another example is Vanguard Personal Advisor. You’ll need a minimum of $50,000 to invest, but you’ll also have access to human, financial planners – all at a low annual advisory fee. In fact, you’ll get unlimited access to a licensed financial advisor, who can answer your questions and even help you develop a personalized portfolio. That’s taking the robo-advisory concept to a whole new level.

How Much Money Can You Make with Robo Advisors?

One of the built-in limitations of robo advisors is information on investment returns. Returns are commonly listed with mutual funds and ETFs, and you can even get that information on individual stocks. But it’s much harder to come by with robo advisors.

Part of the reason for this limitation is the customization factor. It’s nearly impossible for a robo advisor to provide objective investment returns, given that the portfolio of each investor on the platform is customized to the investor’s respective investment profile.

One of the exceptions is Wealthfront. It does attempt to provide historical investment returns on its website. However, there is no general return data.

Instead, Wealthfront recognizes the many different investor profiles and publishes results for each.

But there are 20 return data sets in all, ranging from a Risk Score of 0.5 (risk averse) to 10 (highly aggressive), in increments of half points (0.5, 1.0, 1.5, 2.0, 2.5, etc.).

Below is a screenshot from the Wealthfront website showing the return data for an investor with a risk score of 7.0, which is fairly aggressive:

Now, it’s important to be aware the investment returns provided are historical only. They do not indicate future performance.

In addition, the results in the screenshot are for a more aggressive investor. If you are extremely conservative, with a 0.5 rating, the return results are less than half as robust.

Things Robo Advisors Can’t Do

Despite the many advantages robo advisors have to offer, there are a few things they can’t do. You’ll need to take this into consideration in making your decision to invest with one of these platforms.

1. Most don't offer human-guided financial advice

One of the central aspects of robo advisors is their reliance on automation. As mentioned earlier, when you sign up for a service, you’ll enter your general information, then complete a brief questionnaire that will determine your investor profile. The robo advisor will design a portfolio based on your responses. The portfolio allocation will be established and implemented as soon as you fund your account.

During the entire process, you’ll never speak with an investment advisor, at least not with most robo advisors. You’ll need to be comfortable with the mechanical process that is inherent in robo-advisor investing.

2. Most provide only minimal human contact

Many robo advisors are set up to minimize not only human advice but all human contact. In most cases, the contact will be limited to technical issues regarding your account.

In that way, investing with robo advisors is very impersonal. This is a big part of how the platforms are able to keep management fees so low. The absence of live staff also means greatly reduced payroll and office space requirements. In effect, you’re trading off human contact for low fees.

3. Most do not allow you to choose your own investments

The same automation robo advisors use to simplify the investment process also removes your option to choose your own investments. Most robo advisors do not offer individual stocks as an option. And even the index-based ETFs used are selected from a short list.

That said, there are a few robo advisors that allow you to choose your own investments. As discussed above, M1 Finance lets you choose individual stocks and funds for your portfolio, which are then automatically managed by the platform.

Some other platforms provide limited ability to adjust your portfolio. This is done by retaking the questionnaire provided at the time of signing up. You can choose answers that will result in a more aggressive or more conservative portfolio mix. But the specific choice of investments within your portfolio will still be determined by the robo advisor.

4. Returns will generally be something less than 'The Market'

The performance of the S&P 500 Index has become the most popular benchmark for measuring the performance of the stock market. It’s even stated or implied as representing the overall market. But if you compare the returns you’ll get with a robo advisor to the index, they’re likely to be lower – at least during rising markets.

The reason for this is diversification. No robo advisor will invest 100% of your money in the S&P 500 index at all times. At least some of your money will be spread across bonds and non-U.S. stocks. Given the S&P 500 has outperformed nearly every other asset class over the past decade, the returns on a diversified portfolio will be lower.

As an example, let’s look at the one-year, three-year, and five-year returns provided by Wealthfront for a risk score of 7.0 – presented earlier – with returns for the same time periods for the S&P Dow Jones Equity S&P 500 Index:

Notice that for each time frame the performance of the Wealthfront portfolio has come in well below that of the S&P 500 index.

That doesn’t represent some sort of inherent flaw with Wealthfront’s investment strategy. Instead, it’s the result of the time-honored investment strategy of using diversification in all types of market environments.

You should fully expect your returns will be less than those of the S&P 500 during strong market upturns.

5. Most will not protect you from a declining market

Just as the diversification employed in robo advisor portfolios prevents you from getting the full benefit of stock market returns in bull markets, the same strategy also helps dampen your losses in bear markets. But that diversification won’t provide full protection from declining markets.

Investments held within robo advisor accounts are tied to the financial markets. They’ll follow those markets up and down. If the stock market is declining in a major way, your portfolio will also fall.

Robo advisors attempt to minimize market losses through diversification into different asset classes. These will include, first and foremost, bonds. But it may also use alternative asset classes, like real estate. Most also invest in international stocks and bonds to provide some level of geographic location.

Still, it’s more than likely your portfolio will decline in value in concert with the stock market, since that allocation will represent a major share of most portfolios.

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6. There are some confusing options

Many robo advisors now offer so many options that they can become confusing. For example, Betterment offers their Core, Smart Beta, BlackRock Target Income, and one of three different socially responsible investment portfolios.

Though these portfolio options are being added to attract more kinds of investors, deciding which to participate in can be confusing to the casual investor. The confusion can be even more pronounced against the backdrop of minimal human contact.

Though robo advisors are specifically designed to provide a user-friendly investor experience, you’ll still need to know how you want to invest if you should decide to choose anything more than the most basic option offered.

Summary: How to Decide for Sure If a Robo Advisor Is Worth It for You

How can you know if using a robo advisor is the right investment choice for you?

It’s worth considering one if any of the following apply to you:

• You're completely new to investing and you don’t know how it works.

• You have only a small amount of money, but you want to spread it across a diversified portfolio.

• As much as you may be interested in investing, you don’t have the time to give it the attention it needs.

• You have a large portfolio, but you don’t want to pay a traditional investment advisor the 1+% most require.

• You do engage in self-directed investing, but you’d like to have at least some of your portfolio professionally managed for diversification purposes.

Those are just a few of the primary reasons investors turn to robo advisors, but there may be others that apply to your own personal circumstances.

If you choose to invest with a robo advisor, there are plenty of choices. Do some investigating to determine which platform will best serve your investment needs and preferences.

If you're ready to learn more, here are a few of our favorite robo advisors: Personal Capital, Vanguard Digital Advisor, M1 Finance, and Acorns, which will give you a $10 bonus to get started.

References:

https://www.sec.gov/investor/alerts/ib_fees_expenses.pdf
https://www.wealthfront.com/historical-performance