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What is a robo-advisor?

What is a robo-advisor?
Asked by
Mark Brewster categorie-icon time-icon4 months ago

Sheila Olson
Answered time-icon4 months ago

A robo-advisor is an automated financial planning service that uses machine algorithms and advanced technology to develop and manage an investment portfolio. Because robo-advisors remove the human element from investment management, they are significantly less expensive to use than traditional financial planners, putting professional management services within reach of even small investors.

Betterment launched the first robo-advisor service in 2008 at the start of the Great Recession. The market has exploded since then; there are over 200 digital investment platforms available currently, with more in the pipeline. In 2015, roughly $60 billion was under management by robo-advisors. Today, experts project that figure will reach $2 trillion by 2020. According to financial research firm Hearts & Wallets, about half of all investors aged 53 to 64 have assets managed by robo-advisors, as do about a third of all retirees.

Although wealth management software is new to consumers, financial advisors have been using portfolio allocation software for almost two decades. There is nothing new about automating many investment decisions. The only “new” thing about robo-advisors is that this technology is now available directly to consumers.

Earlier versions of robo-advisor platforms dealt exclusively with taxable accounts and IRAs, but now there are robo-advisors managing more complex investments such as trusts and even 401(k) accounts. Most robo-advisor platforms offer regular portfolio rebalancing, retirement planning, and tax-loss harvesting for taxable accounts. Some offer hybrid services which combine automated investment management with a fixed number of contacts with a human advisor each year.

Robo-advisors generally charge between 0.2% and 0.8% to manage a portfolio, compared to an average of 2% for professional wealth managers. On average, you’ll pay about $40 per year for each $10,000 invested with a robo-advisor. The fees are deducted from your account on a monthly or quarterly basis.

Account minimums, which are a barrier to entry for many retail investors, are low to nonexistent with robo-advisors. You generally need in the neighborhood of $100,000 in assets for a financial advisor to accept you as a client, but you can open an account with a robo-advisor for $500 or less in most cases, although a few platforms have higher minimums of $5,000 to $10,000.

Most robo-advisors offer a fixed number of portfolio options ranging from quite aggressive to more conservative. When you open an account, you’ll answer several online questions, and the platform will recommend a portfolio based on your financial situation and goals.

Robo-advisors generally build portfolios around exchange-traded funds, or ETFs. These are low-cost, passively managed funds that track an underlying stock index, such as the S&P 500 or NASDAQ Composite. In a traditional brokerage account, you usually pay commissions on ETF trades, but these are typically waived with robo-advisors. This eliminates the costs associated with regular portfolio rebalancing. It also makes automatic investing and regular share purchases more affordable. Some robo-advisor platforms do allow investors to trade individual securities, although there is often a minimum account balance required for that service.

The largest stand-alone robo-advisor, Betterment, has nearly $15 billion in assets under management. Among the legacy financial management firms offering robo-advisor services, Vanguard leads the pack, with over $50 billion in managed assets, although Vanguard’s service is not a true robo-advisor but a hybrid, matching each investor to a human financial planner in addition to automated investment management.

Robo-advisors are a good choice for new investors, those with relatively straightforward financial planning needs, and people who prefer a more automatic, hands-off approach to managing their investments. Those with large portfolios, more complex tax situations, or assets such as company stock options, for example, may benefit from a human advisor, or a hybrid approach to financial planning.

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