What Is a Robo Advisor and How Does It Work?

A robo advisor is a digital platform that uses algorithms to provide investment advice and manage your portfolio. It's essentially a computer program that makes investment decisions on your behalf.

Robo advisors are designed to be low-cost and user-friendly, with many offering automated investment services for a fraction of the cost of traditional financial advisors. This makes them an attractive option for individuals who want to invest their money but don't have the time or expertise to do so themselves.

To get started with a robo advisor, you typically need to create an account and answer a few questions about your financial goals and risk tolerance. This information is then used to create a customized investment portfolio that's tailored to your needs.

A robo advisor is a sophisticated computer algorithm that picks investments for you and helps you manage them over time. It's not a robot or a human financial advisor, but rather a digital tool that uses data to make investment decisions.

Typically, a robo advisor provides a questionnaire to set parameters like financial goals, risk preferences, and time horizon. The algorithm then recommends an automated portfolio that aligns with your responses.

Robo advisors are self-guided online wealth management services that provide automated investment advice at low costs and low account minimums. They employ portfolio management algorithms to manage your investments.

You can use a robo investing as you would any account – for retirement, as a taxable investment account, or even for your emergency fund. It's a surprisingly easy way to set up a portfolio, but it helps to know some of the details of robo investing.

Robo advisors provide personalized investment advice tailored to your financial situation and goals. They also offer general financial advice, but it's not tailored to your specific needs.

Traditional portfolio management services often require high balances, whereas robo-advisors typically have low or no minimum requirement. This makes it possible to get started investing quickly – in many cases, within a matter of minutes.

Robo advisors offer several benefits, including cost efficiency and potential performance, which can help you achieve your financial goals without breaking the bank.

Robo advisors are also known for their time-saving features, allowing you to automate your investing strategy and reduce the risk of human error.

With robo advisors, you can start investing with as little as $1, making it accessible to everyone.

Some of the best platforms for automated investing include Wealthfront, SoFi, and Schwab, which have been rated highly for their low fees and user-friendly interfaces.

Here are some key features to look for in a robo advisor:

So, how do robo-advisors work? They're relatively new, but there are many different options available.

To get started, you'll likely need to fill out a survey, providing details about yourself, your financial circumstances, and your future goals. This information helps robo-advisors recommend investment options tailored to your needs.

Most robo-advisors won't let you pick individual funds to invest in, and you also won't be able to choose which investment classes to invest in - they tend to make these decisions themselves.

You can automate your investing strategy with top platforms like Wealthfront, SoFi, Schwab, and more. These platforms offer a range of benefits, including low fees and automatic rebalancing.

SoFi's Automated Investing, for example, offers a low-fee robo-advisor with automatic rebalancing and no-cost access to certified financial planners. You can start investing automatically with as little as $1.

Robo-advisors manage investments using data, specifically data relating to investing theories like Modern Portfolio Theory. They favor passive investment strategies, which means they'll keep your returns in line with the market average.

Here are some key features to look for in a robo-advisor:

If you're new to investing, robo-advisors can be a great way to get started. They offer a range of benefits, including cost efficiency and potential performance.

Robo-advisors typically use low-cost exchange-traded funds (ETFs) and index funds to build portfolios. These funds aim to mirror the performance of a stock market index, such as the S&P 500.

You'll pay fees for these funds, called expense ratios, in addition to the robo-advisor's management fee. This can add up, but it's often lower than what you'd pay with a traditional financial advisor.

Robo-advisors usually offer between five and 10 portfolio choices, ranging from conservative to aggressive. Their algorithm will recommend a portfolio based on your risk tolerance and goals, but you can veto that recommendation if you'd prefer a different option.

If you'd rather pick your own investments, opening a brokerage account might be a better fit. You can find online stock brokers with $0 account minimums and free trades, but you'll need to do your own research and manage your portfolio.

Lifecycle funds and target date funds were among the first types of accounts to use automated portfolio management. They're designed for retirement savings and provide a pre-designed mix of investments that gradually becomes more conservative as the target date approaches.

You can start investing with as little as $1, making it easier to get started with automated investing. The first interaction with a robo-advisor is usually a questionnaire to learn your risk tolerance, goals, and investing preferences.

Robo-advisors tend to make investment decisions based on data, specifically relating to investing theories like Modern Portfolio Theory (MPT). They favor passive investment strategies, which means keeping your returns in line with the market average.

Automated portfolio management functions, such as glide paths, are used to create pre-designed portfolios that gradually shift from aggressive to conservative investments as a target date approaches. This is seen in target date funds and lifecycle funds designed for retirement savings.

Robo-advisors typically offer between five and 10 portfolio choices, ranging from conservative to aggressive. You can veto the recommended portfolio if you prefer a different option.

Some robo-advisors, like SoFi, offer additional perks such as automatic rebalancing and no-cost access to certified financial planners. Other perks may include low fees, low account minimums, and the ability to start investing with small amounts of money.

Here are some of the best automated investing platforms:

Consumer access to robo-advisors has made it possible for middle-class investors to obtain portfolio management services that were previously out of reach due to high minimum investment amounts imposed by traditional human advisors.

The average financial planner has a minimum investment amount of $50,000, while robo-advisors start as low as $500 in the United States and as low as £1 in the United Kingdom.

This means that investors with smaller amounts of money can now access professional portfolio management services that were previously only available to those with larger amounts of investable assets.

Robo-advisors also charge lower fees than traditional financial planners, ranging from 0.2 percent to 1.0 percent of Assets Under Management, compared to 1.35 percent for traditional planners.

Regulation of robo-advisors is also in place to ensure investor protection, with robo-advisors in the United States registered with the Securities and Exchange Commission and those in the United Kingdom regulated by the Financial Conduct Authority.

In Australia, robo-advisors manage client money through the Managed Discretionary Account (MDA) structure, which is subject to regulatory oversight.

The average financial planner has a minimum investment amount of $50,000, making it difficult for middle-class investors to obtain portfolio management services.

Traditional human advisors often have high minimums on investable assets, leaving many investors underadvised or unable to access these services.

In contrast, robo-advisors have lower minimums on investable assets, starting as low as $500 in the United States and as low as £1 in the United Kingdom.

This means that robo-advisors can provide access to portfolio management services for a wider range of investors.

Robo-advisors charge fees ranging from 0.2 percent to 1.0 percent of Assets Under Management, significantly lower than the average fees charged by traditional financial planners, which are 1.35 percent of Assets Under Management.

Regulation plays a crucial role in ensuring the trustworthiness and reliability of robo-advisors.

In the United States, robo-advisors must be registered investment advisors, which are regulated by the Securities and Exchange Commission.

This regulatory framework helps protect clients' interests and maintains the integrity of the financial industry.

In the United Kingdom, robo-advisors are regulated by the Financial Conduct Authority, which oversees their operations to ensure compliance with relevant laws and regulations.

Robo-advisors that manage client money offer discretionary accounts, a feature that sets them apart from micro-investing firms, managed funds, and investing platforms.

In Australia, robo-advisors manage client money through the Managed Discretionary Account (MDA) structure, a regulatory framework that provides an additional layer of protection for clients.

Robo-advisors are much cheaper than in-person human financial advisors, with most charging between 0.25% and 0.50% as an annual management fee. This fee is 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 is typically swept from your account, prorated and charged monthly or quarterly.

You won’t usually pay transaction fees with a robo-advisor, which is a significant advantage over standard brokerage accounts. Robo-advisors frequently waive these charges, saving you money on commissions.

Most robo-advisors also offer low or no investment minimums, which can help some investors get started sooner. This is another potential upside, given the time value of money in the investing process.

Performance is also worth considering, as the portfolio returns of an automated investment account can be comparable to what you’d get with a live investment advisor. This is due to the lower cost of robo investing, in many cases, since lower investment costs help improve overall returns.

Here's a summary of the fees you might expect to pay:

Robo-advisors are generally much cheaper than in-person human financial advisors, with most companies charging between 0.25% and 0.50% as an annual management fee.

You might pay as little as $25 a year for an account balance of $10,000, with the fee typically swept from your account and prorated monthly or quarterly.

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

Robo-advisors frequently waive transaction fees, which is a big plus compared to standard brokerage accounts where you might pay a commission to buy or sell investments.

Here's a breakdown of the typical fees you can expect to pay with a robo-advisor:

It's essential to understand that while robo-advisors may seem low-cost, the fees can add up over time, reducing your annual return by 0.25% to 0.50%.

Many robo advisors offer low or no investment minimums, which can help some investors get started sooner, taking advantage of the time value of money in the investing process.

Lower investment costs can improve overall returns, making the portfolio returns of an automated investment account comparable to what you'd get with a live investment advisor.

Robo advisors work for you 24/7, giving you the flexibility to make changes to your investments at any time.

There is no one average rate of return for a robo-advisor because each robo-advisor employs different investing approaches and strategies.

Investing with a robo-advisor can be a cost-effective way to outsource portfolio management, automating portfolio selection and rebalancing, and allowing you to invest in low-cost ETFs passively.