A robo-advisor is an automated investment management service that is an alternative to a traditional financial advisor. An online brokerage is simply a broker that enables investors and traders to self-direct their trades over the Internet instead of calling a broker or visiting his office to complete the transaction.
They offer two very different services. People who open brokerage accounts are typically comfortable doing their own research and making their own decisions about how to invest their money. They are self-directed investors who understand the underlying principles of making advantageous trades.
People who choose robo-advisors are seeking guidance in building their portfolios and prefer to leave the details and transactions to someone else. They prefer a more “set it and forget it” approach to building a taxable portfolio or retirement account. In many cases, they are new investors or people with smaller portfolios, although an increasing number of mature investors with sizeable portfolios are turning a portion of their assets over to robo-advisors.
The actual mechanics of using an online brokerage versus a robo-advisor are very different. Most online brokerages offer sophisticated trading platforms with tools and features such as real-time streaming quotes and watch lists, stock, option, and fund screeners, backtesting, and access to third-party research. They allow traders to place different types of orders, trade options, and buy on margin, and they usually offer a wide variety of assets including stocks, bonds, futures, mutual funds, and IPOs.
Some are more beginner-friendly, with a simpler trading platform, and have more robust educational features to teach newbies the basics of investing. Others are aimed at active traders or fundamental investors who want more research and analytical tools, and trading options. Regardless of the platform specifics, all transactions are initiated by the account holder as opposed to an advisor.
Robo-advisors, on the other hand, aren’t trading platforms at all. An investor just answers a few questions in an online questionnaire, supplies his personal information, and chooses the portfolio he prefers from among the recommendations supplied by the advisor. As money is added to the account, it’s used to buy the assets, typically ETFs, in the proportions outlined in the pre-set portfolio. The robo-advisor initiates and executes all trades on the investor’s behalf.
In addition, robo-advisors automatically handle other transactions, such as regular portfolio rebalancing and tax-loss harvesting to improve the tax efficiency of the underlying investments. If you’re investing in an online brokerage account, you’re responsible for rebalancing transactions and tax-loss calculations.
Another way that robo-advisors and online brokers are different is in their fee structures. Online brokers are transaction-driven. You pay a commission or fee every time you execute a trade; the fee is generally between $5 and $20, with most brokers in the $5 to $7 range. Robo-advisors, on the other hand, charge a percentage of the value of your portfolio for managing your account, typically between 0.25% and 0.50%.
The vast majority of assets under management by robo-advisors are invested in ETFs; few trade in individual securities or other asset classes. ETFs carry additional fees, known as the expense ratio, which are deducted from your account balance. These are generally quite low, 0.10% or less, and you’ll pay them whether you hold ETFs in your brokerage account or your robo-advisor account. Because ETFs are traded like stocks, you usually pay a commission on every trade, but most robo-advisors and online brokers offer commission-free trades on some or all of their ETFs, so this is less of an issue than you might expect when comparing costs.
There is very little overlap in the services offered by a discount online broker and a robo-advisor. Which one you choose depends entirely on what you want to accomplish. If you’re looking for an inexpensive way to research and trade stocks and other assets to build your own portfolio, you’ll want to find a good online broker. If you’re looking for someone to build and manage a portfolio for you at the lowest possible cost, you’ll look for a good robo-advisor.