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How do robo-advisors get paid? How much do they charge?

How do robo-advisors get paid? How much do they charge?
Asked by
Benjamin Schmitz categorie-icon time-icon4 months ago
1 Answer Answer Question

Sheila Olson
Answered time-icon4 months ago

Robo-advisors, or automated investment management platforms, are typically considerably less expensive than using traditional financial advisors. Most make money by charging customers a percentage of assets under management, typically between 0.25% and 0.8%, depending on the platform. You still pay expenses associated with your investments, which are usually low-cost ETFs with expense ratios of 0.25% or below.

Some robo-advisors don’t charge customers anything for managing their investments; WiseBanyan and Wealthfront are two examples of stand-alone no-cost robo-advisors. Among legacy financial management companies, Charles Schwab also offers robo-advisor services, known as Intelligent Portfolio, at no direct cost to investors.

Although a robo-advisor doesn’t charge a management fee, it still has ways to make money off your money. For example, some charge commissions on the trades they make in your portfolio. Others may have a maintenance fee on accounts below a particular balance. Management fees may also vary depending on your account balance. Wealthfront’s 0% management fee only applies to account balances below $50,000; after that, they charge 0.25% to manage your assets. Hedgeable, on the other hand, starts at 0.75% for balances up to $1 million, when the fee drops to 0.30%.

Some robo-advisors make money through kickbacks from proprietary funds. For example, if a robo-advisor recommends an ETF from a particular company, that company pays the robo-advisor a “referral” bonus.

Other robo-advisor platforms build cash allocation into their revenue model. They hardwire a particular asset allocation formula into each portfolio, such as 60% stocks, 35% bonds, and 5% cash. Charles Schwab has particularly high cash allocations of between 6% and 30% of the portfolio, and these can’t be changed on a case-by-case basis. That’s significant for investors, because there are indirect opportunity costs associated with high cash allocation.

A $500,000 portfolio with a 10% mandatory cash allocation will experience significant cash drag on returns. Assuming a typical portfolio of 60/40 stocks and bonds earns 7% a year, you lose out on about $3,500 in returns on the cash portion of your account. Over the long haul, the impact on your portfolio is dramatic.

One other expense to keep in mind with robo-advisors relates to transaction fees and commissions on trades. Every time the advisor buys or sells on your behalf, you may be charged a fee. Some platforms waive these transaction costs, but others charge between $5 and $20 per trade.

In most cases, robo-advisors cost significantly less than traditional human financial advisors, but their menu of services is also limited to straightforward financial planning needs. Most robo-advisors stick to basic retirement planning, portfolio rebalancing, and tax loss harvesting. More complex financial planning needs, such as wealth protection or integrated estate planning, are beyond their capabilities.

Some robo-advisor platforms have addressed these shortcomings by offering hybrid packages that enable limited access to a human financial planner along with automated portfolio management services. Betterment, for example, offers “advice packages” tailored to specific life events. Vanguard pairs each robo-advisor client with a certified financial planner.

If you’re considering using a robo-advisor, be sure to understand all the costs involved, direct management fees and fund expense ratios, as well as transaction expenses and indirect opportunity costs. Each of those will have an impact on overall returns.

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