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 offer a relatively hands-off way to manage your investments.
Also known as automated investing or online advisors, robo-advisors use computer algorithms and advanced software to build and manage a client's investment portfolios, offering such features as automatic rebalancing and tax optimization. They require — and often offer — little to no human interaction.
What robo-advisors cost
This kind of management isn't free, of course. But robo-advisors are cheaper than what you'd pay a human financial advisor, often by a long shot. Most companies charge an annual management fee of 0.25% and 0.50% of your assets under the robo-advisor's care. That means on an account balance of $10,000, you might pay $25 to $50 a year. The fee typically is swept from your account, prorated and charged monthly or quarterly.
What you won't usually pay at a robo-advisor are transaction fees.
How robo-advisors work
Most robo-advisors manage individual retirement accounts and taxable accounts. Some also manage trusts, and a select few will help manage your 401(k). Pay close attention to minimum investment requirements, which can range from free to $10,000 or more.
When you sign up with a robo-advisor, your first interaction will almost always be a questionnaire designed to feel out your risk tolerance, goals and investing preferences. Robo-advisors generally offer five to 10 portfolio choices, ranging from conservative to aggressive. The service's algorithm will recommend a portfolio based on your answers to these questions, though you should be able to veto that recommendation if you'd prefer a different option.
Robo-advisors largely build their portfolios out of low-cost exchange-traded funds and index funds, which are baskets of investments that track an index such as the Standard & Poor's 500. An S&P 500 ETF would aim to mirror the behavior of that index, investing in the stocks of the 500 companies within it. You'll pay the fees charged by those funds — called expense ratios — in addition to the robo-advisor's management fee.
Typical robo-advisor services
The formula for many of these advisors is the same: automate investment management services so they can be done by a computer at a lower cost. At most robo-advisors you can expect:
A recommendation of a diversified portfolio that aligns with your goals and risk tolerance.
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-loss harvesting and other tax-strategy offerings on taxable accounts.
You can expect the cost and minimum investment requirements of these services to increase in step with the level of human involvement. Personal Capital offers dedicated financial advisors, requires a $100,000 initial deposit and charges 0.89% per year. Vanguard Personal Advisor Services and Charles Schwab Intelligent Advisory offer access to a rotating cast of advisors for a lower minimum deposit and fee. Vanguard requires a $50,000 minimum and charges 0.30% a year; Schwab requires $25,000 and charges 0.28%.
These hybrid services can be a good option because they at least partially fill in the major gap left by strictly digital robo-advisors: Some investors want, and need, human interaction.