What Is A Robo-Advisor? Definition and How It Works - NerdWallet (2024)

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If you’ve ever wished for a robot to clean your house or walk your dog, you’ll likely understand the appeal of a robo-advisor. These services don’t do windows or pet-sit, but what they offer is arguably more valuable: a relatively hands-off way to invest.

Robo-advisor definition

Robo-advisors — also known as automated investing services — use computer algorithms and software to build and manage your investment portfolio. Services can include automatic rebalancing and tax optimization, and require little to no human interaction — but many providers have human advisors available for questions.

Traditional portfolio management services often require high balances; robo-advisors typically have low or no minimum requirement. Because of that and their low costs, robo-advisors let you get started investing quickly — in many cases, within a matter of minutes.

Human financial planners also are not particularly diverse. Among the 96,412 certified financial planners reported in 2023, only 23.7 % were women and less than .1% were nonbinary. The majority of all CFPs — 82.5% — are white. If you want, but can't find, a human advisor who fits your needs and values, a robo could be an alternative for you. For example, HBCU Legacy is a robo-advisor geared toward students and alumni of historically Black colleges and universities, and Ellevest is a robo-advisor geared toward women investors.

» Ready to get started? Check out NerdWallet's picks of best robo-advisors

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Are robo-advisors worth it?

When considering whether a robo-advisor is worth it, take into account the following:

Robo-advisor fees and account minimums

Robo-advisors are much cheaper than an-person human financial advisor. Most companies charge between 0.25% and 0.50% as an annual management fee, though there are even free options such as Sofi Automated Investing.

As with many other financial advisors, fees are paid as a percentage of your assets under the robo-advisor’s care. For an account balance of $10,000, you might pay as little as $25 a year. The fee typically is swept from your account, prorated and charged monthly or quarterly.

You won’t usually pay transaction fees with a robo-advisor. In a standard brokerage account, you might pay a commission to buy or sell investments, both during a rebalancing of your portfolio and when you deposit or withdraw money. Robo-advisors frequently waive these charges.

Some robo-advisors require $5,000 or more as an initial investment, but some have no required account minimum, and others have account minimums of $100-$500.

» Read more: How much does a financial advisor cost?

🤓Nerdy Tip

Feeling overwhelmed? If thinking about money is stressful, it may help to talk with a financial therapist.

Automated investing vs. hands-on investing

If you want to start growing your wealth, but you're not quite sure how to get started, robo-advisors can be one way for beginners to start investing. When you sign up with a robo-advisor, your first interaction will almost always be a questionnaire, designed to find out your risk tolerance, goals and investing preferences.

Instead of you researching which stocks or funds to buy, robo-advisors largely build their portfolios out of low-cost exchange-traded funds (ETFs) and index funds, which are baskets of investments that aim to mirror the performance of a stock market index, such as the. You’ll pay the fees charged by those funds — called expense ratios — in addition to the robo-advisor's management fee.

Robo-advisors generally offer between five and 10 portfolio choices, ranging from conservative to aggressive. The service’s algorithm will recommend a portfolio based on your answers to the questionnaire, but you should be able to veto that recommendation if you’d prefer a different option.

If you'd prefer to pick your own investments, opening a brokerage account might be a better option. You can find online stock brokers who offer $0 account minimums and free trades. You'll have to do the research on stocks yourself, and manage your own portfolio, but you'll skip some of the fees that can come with robo-advisors. (Read our primer on how to invest in stocks for more on DIY investing.)

» Not sure which type of advisor is right for you? Learn how to choose a financial advisor

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Is a robo-advisor right for you?

That depends. Do you want to be a hands-on investor? Or do you prefer a hands-off approach? If you want to set it and forget it, a robo-advisor might be a solid choice.

The formula for many advisors is the same: automate investment management so it can be done by a computer at a lower cost. At most robo-advisors, you can expect:

  • Regular rebalancing of that portfolio, either automatically or at set intervals — for example, quarterly. Most advisors do this via computer algorithm, so your portfolio never gets out of whack from its original allocation.

  • Financial planning tools, such as retirement calculators.

  • Tax strategies, such as tax-loss harvesting, which involves selling losing investments at a loss to offset capital gains taxes on sales of profitable investments.

Most robo-advisors manage both individual retirement accounts and taxable accounts. Some also manage trusts, and a select few will help manage your 401(k). It comes down to whether you want automated portfolio management or not.

And if you don't want to manage your own portfolio, but you want or need more comprehensive financial planning than a robo can provide, here's one middle ground option: online financial planning services.

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What are online planning services?

These companies operate as online financial advisors, and they're sort of a robo-advisor, traditional advisor hybrid: You'll receive unlimited access to a team of financial planners (or in many cases, your own dedicated financial advisor), but you'll meet virtually via phone or video rather than in-person. This model means you get human oversight and interaction at a higher cost than a robo, but at a lower cost than a traditional financial advisor.

You can expect the cost and minimum investment requirements of online financial advisors to increase with the level of human involvement, certification (such as access to a certified financial planner) and personalization:

  • Facet Wealth offers each client a dedicated certified financial planner, and has a $0 minimum. It charges a fee of $2,000-$8,000 per year, based on the complexity of your planning needs. You get custom advice and a complete financial plan, and the service includes investment management.

  • Charles Schwab Intelligent Portfolios Premium offers access to a team of advisors who will prepare a custom financial plan for you and manage your portfolio. Schwab requires a $25,000 account balance, and charges a flat fee of $30 a month, plus a one-time planning charge of $300.

  • Vanguard Personal Advisor offers access to a team of financial advisors for a $50,000 account minimum and a 0.35% fee. You'll get a customized financial plan, portfolio management and access to financial planning tools.

» View a full list of the best financial advisors

These hybrid services can be an additional option because they at least partially fill in the major gap left by strictly digital robo-advisors: Some investors want, and need, human interaction.

What Is A Robo-Advisor? Definition and How It Works - NerdWallet (2024)

FAQs

What Is A Robo-Advisor? Definition and How It Works - NerdWallet? ›

Robo-advisor definition

What is a robo-advisor and how do they work? ›

A robo-advisor (sometimes without the hyphen, as roboadvisor) is a digital platform that provides automated, algorithm-driven financial planning and investment services with little to no human supervision. A typical robo-advisor asks questions about your financial situation and future goals through an online survey.

Do millionaires use robo-advisors? ›

High-net-worth investors exited robo-advisor arrangements at the highest rates. Here's how the data broke down along asset levels: $50,000 or less: A drop from 23.6% to 20.6% in 2022, which translates to a decrease of 3 percentage points.

What are 2 cons negatives to using a robo-advisor? ›

The generic cons of Robo Advisors are that they don't offer many options for investor flexibility. They tend to not follow traditional advisory services, since there is a lack of human interaction.

Why would you use a robo-advisor instead of a financial advisor? ›

For core investing and planning advice, a robo-advisor is a great solution because it automates much of the work that a human advisor does. And it charges less for doing so – potential savings for you. Plus, the ease of starting and managing the account can't be overstated.

What is a robo-advisor in simple terms? ›

Robo-advisors vary from firm to firm, but are generally online services that provide automated portfolios based on your preferences. Robo-advisors weigh. personal preferences against unpredictable forces. to automatically recommend a portfolio. that fits an investor's specific needs.

What is a robo-advisor in your own words? ›

Robo-advisors — also known as automated investing services — use computer algorithms and software to build and manage your investment portfolio. Services can include automatic rebalancing and tax optimization, and require little to no human interaction — but many providers have human advisors available for questions.

What is the biggest downfall of robo-advisors? ›

Limited Flexibility. If you want to sell call options on an existing portfolio or buy individual stocks, most robo-advisors won't be able to help you. There are sound investment strategies that go beyond an investing algorithm.

What is one of the biggest downfalls of robo-advisors? ›

Limited human interaction: Robo-advisors do not offer the same level of human interaction as traditional financial advisors. This can be a disadvantage for investors with more complex financial needs or investment goals.

How risky are robo-advisors? ›

2 Cybersecurity threats. Another risk of using robo-advisors is that they may be vulnerable to cyberattacks that compromise your data and assets. Robo-advisors store and process large amounts of sensitive information, such as your identity, bank accounts, portfolio holdings, and transactions.

How much would I need to save monthly to have $1 million when I retire? ›

Suppose you're starting from scratch and have no savings. You'd need to invest around $13,000 per month to save a million dollars in five years, assuming a 7% annual rate of return and 3% inflation rate. For a rate of return of 5%, you'd need to save around $14,700 per month.

Can robo-advisors lose money? ›

Can You Lose Money with a Robo-Advisor? Robo-advisors are much quicker to respond to changes in your assets, but they are not able to predict market outcomes. It is just as possible to lose money using a robo-advisor as it is using a human advisor.

Should I use a robo-advisor or do it myself? ›

Doing it yourself can give you more control, flexibility, and customization over your investments, but it also requires more research, monitoring, and discipline. You should consider your goals, risk tolerance, and investment style before choosing between a robo-advisor or doing it yourself through an online broker.

What are some of the most commonly used robo advisers today? ›

Compare the Best Robo-Advisors
CompanyAccount Minimum
Acorns Best for Those Who Struggle to Save$0
Ellevest Best for Women Investors$0 for Ellevest Digital Plan or $1,000,000 for Ellevest Private Wealth Management
E*TRADE Best for Mobile$500
Merrill Guided Investing Best for Education$1,000
4 more rows

What's a disadvantage of using a robo-advisor? ›

Drawbacks of Robo-Advisors

Some robo-advisors only offer human support for tech- and account-related questions, which means there's no one to answer questions about your investments. Others have a hybrid model which may give you access to human advisors.

When should you stop using a robo-advisor? ›

For hands-off investing with minimal fees, a robo-advisor could suffice. They can be a great choice for newer, younger investors. But for advanced planning and strategy, a human touch may still be required for advice you can trust.

Can you withdraw money from a robo-advisor? ›

You can withdraw your balance at any time, subject to minimum account requirements. Typically, the withdrawal process takes between 3-5 business days to be completed. If you wish to keep your Robo-Advisor account active, you'll be unable to withdraw any amount that would result in your balance dropping below $100.

Is a robo-advisor a good idea? ›

For some, the simplicity, accessibility, and lower costs make them a very appealing choice. However, for those desiring more personalized service and sophisticated investment strategies, a human financial advisor may be worth the additional cost.

How much does it cost to use a robo-advisor? ›

Funds' expense ratios: The robo-advisor will invest your money in various funds that also charge fees based on your assets. The fees can vary widely, but across a portfolio they typically range from 0.05 percent to 0.25 percent, costing $5 to $25 annually for every $10,000 invested, though some funds may cost more.

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