Robo-advisors aren’t barred by any regulatory authority from investing in certain asset classes; they are free to invest a clients’ money in any type of security they choose. However, the vast majority of them choose to invest in exchange-traded funds, or ETFs because those funds closely align with the robo-advisor business model.
Robo-advisors are low-cost alternatives to traditional financial advisor services. They use complex algorithms to develop risk-adjusted portfolios and recommend these pre-established portfolios to their clients based on their risk tolerance and investment goals. Investment management and account maintenance is automated and services such as regular rebalancing to restore correct asset allocation parameters and tax-loss harvesting for taxable accounts are included in the management fee.
The robo-advisor business model rides on the coattails of the passive management trend. Over the past decade or so, U.S. investors have massively shifted their assets out of costlier actively managed mutual funds into low-cost index funds and ETFs, which are pegged to an underlying index and seek to simply replicate its returns. Where actively managed funds carry expense ratios of up to 2% or more, especially for more esoteric funds, passively managed ETFs can be held for as little as 0.04%.
With over 2,000 ETFs to choose from, it’s easy for robo-advisors to select low-cost funds to round out a well-balanced, diversified portfolio with broad exposure to a variety of sectors and markets. These no-fuss investments help robo-advisors keep the management fees low. Some, like WiseBanyan charge investors nothing to manage their money, although most tend to charge between 0.25% and 0.50% of assets for their services.
The robo-advisor industry is still in its infancy; the oldest, Betterment, was launched in 2008. As the market continues to expand, however, some robo-advisors are branching out into other asset classes. Hedgeable is one of the more sophisticated robo-advisor platforms, offering over 200 options to customize a portfolio. They also offer a wide variety of asset classes including U.S. and international equities, Bitcoin, real estate, commodities, and currency. Of course, their fees are substantially higher than most of the other robo-advisors, although charges go down as your account balance goes up.
Vanguard Personal Advisory Services is a robo-advisor hybrid that combines personal advice from a human advisor with automated investment management services. It also offers more asset classes than basic ETFs, including Vanguard’s actively managed mutual funds, individual bonds, and tax-free muni bond funds.
Wealthsimple is another robo-advisor offering individual stocks, although these are aimed at socially responsible investing portfolios and halal choices compliant with Islamic law. It’s also a hybrid platform that connects you with a professional advisor.
If you’re interested in investing in individual stocks, you may be better served with a low-cost online brokerage account for the portion of your money you don’t want to hold in ETFs. You’ll pay a higher management fee for robos offering these asset classes, plus you’ll be limited to the equities available in the preset portfolios. And while most robo-advisors waive commissions on ETF trades, you’ll still usually be charged for individual stock trades. It’s easy to find a discount broker offering trades for $10 or less, which will save you money and give you more flexibility in your investment options.