Do You Need a Robo-Advisor to Invest?

What is a Robo-Advisor?

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It’s been more than a decade since the first robo-advisors went into operation. While it sounds like they’re human-looking androids that sit behind desks dispensing financial advice — and wouldn’t that be cool! — I’m afraid that’s a scenario that won’t play out until far in the future.

Let’s define what is a robo-advisor. In brief, it’s an automated financial advisor and investment platform that uses a software algorithm to build and manage your portfolio so you don't have to. In other words, a computer program, though one that’s very sophisticated.

Why are they becoming more popular?

Playing the market, and by that I mean other than investing in your work 401(k) or having a buy and hold strategy in something like an S&P 500 fund, can be dangerous for those not steeped in market nuances or for those who don’t have the time to study the market’s intricacies. This is even more true today, when the economy is being roiled by inflation, volatility, politics, and other factors. How do you invest when there are so many things you have to consider?

That’s where robo-advisors come in. These online investment platforms automatically manage your investment portfolio based on your personal financial goals. AI-based solutions, they can make it easier for first-time investors or for anyone who would prefer to start building an investment portfolio by setting it up and then “forgetting” about it. Robo-advisors are also generally much more affordable than traditional financial advisors, and typically less risky than actively trading stocks.

But what are the costs?

Fees vary depending on platform, but typically you're looking at annual fees around 0.20% to 0.25% of your balance. Some platforms don't charge fees based on your balance and instead charge monthly subscription fees. That’s a big discount from brokerages’ or financial advisors’ fees that usually start at 1% annually but can be much higher.

How do robo-advisors know how to invest your money?

When you sign up with any robo-investing platform, you'll first have to answer a few questions about the type of investor you are and your financial plan. These questions will include factors such as your risk tolerance, expense ratio, minimum investment, and when you plan to cash out your investments. These factors will influence which investment option the robo-advisor will choose, and should provide the robo-investing platform with the information it needs to build the ideal investment portfolio for you. During your time investing with it, your robo-advisor should continue to evolve as the markets and your investment options, financial plan, risk tolerance and overall finances change.

All of this helps a robo-advisor ensure you have a diversified portfolio best set up to achieve your financial goals, such as earning enough money to add to your retirement account, paying off a mortgage or student loans, or saving for a dream vacation.

There are also interactive robo-advisors that can help you make sense of your investment options and better understand concepts like socially responsible investing. These are available on multiple platforms now, including two of the biggest names in this space: Betterment and Wealthfront.

Who Should Use a Robo-Advisor?

You who may want to use a robo-advisor if:

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.
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 their 1+%.
You are engaged in self-directed investing, but you’d like to have at least some of your portfolio professionally managed for diversification purposes.

Of course, there are some disadvantages to robo-advisors:

Automation means they usually don’t offer human-guided financial advice.
Most provide very minimal human contact; that makes them impersonal.
Most don’t allow you to choose your own investments.
Returns are often less than market returns.
Most won’t protect you in a declining market.
The options available for the types of investing they do can be confusing.

Which Robo-Advisors are Best?

This is a question that’s best answered by your own due diligence. I can’t recommend one without knowing your personal circumstances and financial situation. However, the following robo-advisors are on the “best of” lists of C-Net, Forbes, and CNBC.

Betterment

This platform was one of the first robo-advisors. It is also one of the most popular financial planning robo-advisors. It has only one fee of 0.25% annually on your balance (or $25 for every $10,000 you invest). Betterment also offers a premium tier for just 0.15% more, for a total 0.4% annual fee. This higher tier gives you unlimited access to certified financial planners and advice on all your investments, even those that aren't with Betterment. There’s also automatic rebalancing and tax-loss harvesting so you won't hang on to assets that aren't working their hardest for you. Plus, the $0 minimum balance means you can get started right now.

Wealthfront

You can get up to $5,000 managed for free through its referral program, when a friend funds an investment or cash account. Unlike other robo-advisors, Wealthfront also offers a 529 college savings plan and an 0.1% APY checking account with debit card access.

SoFi

This robo-advisor was originally set up for handline loans, but now has included financial investments. SoFi doesn't charge any fees for automated investing, so your money goes to your investments — not to someone or something managing it. Additionally, you have access to financial experts at any time by email, phone or chat. It is also a fiduciary, which should mean it won't sell you unnecessary products or give you financial advice that doesn't work for you. You can start by investing with as little as $1. No matter your account portfolio balance, you have free, unlimited access to human financial planners in case you need specific help.

You can also invest in cryptocurrency through SoFi — including Bitcoin and Ethereum — and when you make your first trade of $10 or more, SoFi will give you $10 in Bitcoin. As another fun introductory perk, you can play a "claw game" when you download the SoFi app, giving you the chance to win up to $1,000.

Ellevest

Although anyone can sign up, Ellevest was created by women especially for women. It launched with a fee-based model but has now shifted to a flat monthly membership fee. For $1 a month, the Essential plan gives you access to investing and banking tools, educational materials and a 20% discount on the company's coaching service (sessions start at $125). The Plus plan, which costs $5 a month, adds personalized retirement account planning. And the $9-a-month Executive tier accommodates multigoal investing and management of up to six investment accounts.

So, what’s meant by “especially for women?” The Ellevest algorithm bases your asset allocation investments on important realities for women, including pay gaps, career breaks, and average lifespans, since women historically earn less than men do — and live longer. You also have the option to select impact portfolios (companies that match your investment goal).

Conclusion

I believe that robo-advisors may be a big part of the future for small investors. However, when doing your due diligence check to see if the specific robo-advisor has lagged, matched, or beaten the S&P 500 over the course of its existence. A fund that tracks the S&P 500 is inexpensive as far as fees go, as it’s not managed, but only invests in the stocks within the S&P. Also compare the fees of the robo-advisors to the fees of the funds. Historically, most robo-advisors have not beaten the S&P 500 Index, so you’ll definitely want to find one that has, and hope it continues to do so in the future.

Disclaimer: The information about providers and services contained in this blog post does not constitute endorsement or recommendation by PaulGravette.com. It is your responsibility to verify and investigate providers and services. Please consult your own professional advisor for all advice concerning financial matters in connection with the services needed.

Paul GravetteSeptember 12, 2022