A robo-advisor may assist you in automating your retirement and other financial objectives investment. The notion of a robo-advisor is straightforward, but for novice investors, the idea of having a computer algorithm determine your assets may be strange. We’ll go through the basics of robo-advisors and teach you all you need to know about them.

What Is a Robo-Advisor and How Does It Work?

A robo-advisor (sometimes spelled robo, roboadvisor, or robo-adviser) is a form of brokerage account that automates the investment process. Because they invest your money in prebaked portfolios made up mostly of specifically picked, low-fee exchange-traded funds, most robos charge lesser fees than traditional financial counselors (ETFs). For sophisticated investors or those with greater account balances, some robo-advisors can provide access to additional more tailored investing possibilities.

With a robo-advisor, you may choose between taxable brokerage accounts and tax-advantaged individual retirement accounts (IRAs). Most robos provide a variety of IRAs, including regular, Roth, and SEP IRAs, and will assist you with choose the best account type for your requirements.

Many robo-advisors can help you save for multiple personal finance goals at the same time by dividing your portfolio into sub-portfolios with different asset allocations—for example, a growth-oriented allocation for your home down payment goal and a more income-oriented allocation for your retirement goals. Robo-advisors are increasingly providing basic financial services, such as cash management and savings accounts.

Robo-advisers, like traditional human financial advisors, are regulated as Registered Investing Advisors (RIAs) by the Securities and Exchange Commission (SEC), which means they have a fiduciary obligation to look out for your best interests when it comes to investment decisions. The Securities Investor Protection Corporation insures robo-advisors’ accounts in most cases (SIPC).

What Is a Robo-Advisor and How Does It Work?

The “robo” in “robo-advisor” refers to the platform’s automated functions. The automation starts the moment you join up, and the onboarding process usually starts with a questionnaire to assist the software that powers a robo-advisor understand your present finances, financial objectives, and risk tolerance.

If you said you wanted to save for retirement, the robo-advisor would probably suggest an IRA over a taxable account, with a portfolio of ETFs geared toward long-term growth. If you said you wanted to save for a down payment on a house, the robo may suggest a taxable account with an ETF portfolio that was balanced for short-term gain.

You may change your asset allocation with certain robo-advisors. Continuing with the previous example, if this feature was available and your new robo-advisor recommended that your retirement portfolio contain 80 percent stocks and 20 percent bonds, you might be able to adjust the allocation to 90 percent stocks and 10 percent bonds, introducing a bit more risk into the mix.

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Your investments are chosen by Robo-Advisors

It’s crucial to remember that one of the biggest benefits of robo-advisors is that you don’t have to choose the specific stocks and ETFs that make up your portfolio. Low-cost index fund ETFs are pre-selected by robo-advisors (and sometimes other investments, like mutual funds). Broad-market funds that invest in U.S. equities, overseas stocks, bonds, and real estate investment trusts are the most common (REITs). Themed portfolios, such as a socially responsible investment portfolio, may be available.

ETFs that invest in index funds have relatively low costs and provide a lot of diversity. Lower-cost index funds have historically outperformed higher-cost, actively managed funds in terms of long-term investment performance.

Portfolio Theory in the 21st Century

Many robo-advisors base their portfolios on Modern Portfolio Theory (MPT). MPT tries to diversify portfolios in order to maximize profits while reducing risk. Consider MPT to be an extension of the “don’t put all your eggs in one basket” philosophy to your financial portfolio. MPT raises the probability that while some of your assets are down, others will be up by investing in a diverse variety of asset types. This seeks to keep your portfolio going upwards even when markets are erratic.

Most robo-advisors provide diversity as well as automated portfolio rebalancing and, increasingly, tax-loss harvesting. Portfolio rebalancing ensures that you maintain the correct mix of investment types to meet your objectives when market circumstances change, and tax-loss harvesting may help you reduce the amount of capital gains taxes you owe over time.

What Does it Cost to Hire a Robo-Advisor?

Robo-advisors typically charge 0.25 percent to 0.50 percent of your assets under management (AUM) in yearly management fees, however others charge a fixed monthly membership fee instead. One of the main benefits of robo-advisers is their lower costs when compared to conventional financial advisors.

Typical annual fees for traditional financial advisers are roughly 1.0 percent of AUM (fees may decrease for clients with larger balances). A 0.25 percent robo-advisor cost on a $100,000 investment balance would be $250 per year, whereas a 1.0 percent fee would be $1,000 per year.

Fees compound over time, just like your investment balance, and may eat up a considerable amount of your long-term gains: On a $100,000 beginning balance, a 1% advisory charge might cost you about $30,000 more over 20 years than a 0.25 percent fee.

There Aren’t Always Free Robo-Advisors

SoFi Automated Investing, M1 Finance, Axos Invest (previously Wisebanyan), Schwab Intelligent Portfolios, and Fidelity Go are among the robo-advisors that promise to charge no management costs. When you read the small print, you’ll find that Schwab Intelligent Portfolios requires you to retain a portion of your portfolio in cash (Schwab receives interest on that sum, not you), whilst Fidelity’s service is only free for balances under $10,000.

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Fees for Expense Ratio

You’re usually responsible for expenses linked with the goods in which the robo-advisor invests your money, in addition to management fees. Even while ETFs offer lower cost ratios than mutual funds, you’ll still be paying them in some manner.

Index fund ETFs have an average expense ratio of 0.21 percent, but they may be as low as 0.02 percent. This works up to 21 cents or 2 pennies for $100 invested each year. However, you will not be billed for these fees. They’re usually withdrawn from a fund’s profits or cash holdings, and they’re subtracted from the rate of return automatically.

Common Robo-Advisor Characteristics

Similar services are available from a number of robo-advisors. These are some of them:

Investing that is automated: All robo-advisors allow you to set up automatic contributions to your diverse portfolio. The platform selects how your donations are distributed among your investments. You are usually not engaged in investing decisions after completing your first questionnaire.

Automatic portfolio rebalancing is a feature offered by several robo-advisors. This means they modify the proportion of different kinds of investments you have depending on market performance to maintain them in line with your financial objectives. Portfolio drift might occur if the value of your stocks dropped one year and took up less space in your portfolio than you wanted. Rebalancing your portfolio puts you on track to reach your objectives. Betterment, Wealthsimple, and Acorns are three robos that rebalance depending on predefined drift percentages. Others (Ellevest, Wealthfront, Personal Capital, and SoFi) rebalance their portfolios on a regular basis.

Tax-loss harvesting: Some robo-advisors will optimize your portfolio to save you money on taxes. Betterment and Wealthfront, for example, provide tax-loss harvesting services, which allow investors to sell lost assets in a tax-efficient manner to offset capital gains taxes. This is accomplished without incurring an additional price. Axos, for example, charges an additional price for this service, which it refers to as “Tax Protection.”

Personalized financial planning: Some robo-advisors, such as Betterment, provide a la carte financial planning services. Others, such as Personal Capital and Wealthsimple, provide tiers of management services depending on your investment amount. Dedicated financial advisers build customised strategies and customize your asset management, and these services are included in the advising fee you pay.

Goal-based accounts: While virtually all robo-advisors provide access to taxable investment accounts and retirement accounts, the majority of them also enable you to build goal-based accounts. Wealthfront, for example, allows you to set up a 529 college savings plan. Other robos, such as Acorns and Stash, allow you to setup custodial accounts for your children to invest in. Leading robo-advisors will also let you invest for several objectives at the same time using various account types.

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Other banking services: A growing number of robo-advisors now provide FDIC-insured checking, savings, and cash management accounts. Cash management accounts like Wealthfront and Betterment enable you to make unlimited monthly withdrawals and provide attractive interest rates. M1 and other similar platforms even provide low-interest loans.

Do You Need a Financial Advisor or a Robo-Advisor?

Not everyone is a fan of robo-advisors. If your financial position is complex or you wish to invest in more than index ETFs or a small number of other assets, working with a financial adviser may be a better option. If you’re looking for a traditional financial counselor, consider the following:

While some robo-advisors allow you to personalize specific components of your portfolio, the majority of them put you in a pre-built portfolio that is tailored to your investment schedule and risk tolerance. Financial advisers may also utilize software to create portfolios, but they may provide considerably more customized alternatives and a much larger range of investment opportunities.

You may wish to employ a financial adviser or a brokerage account in addition to a robo-advisor if you want to trade equities or invest in particular stocks and bonds. You can only trade with a few robo-advisors. Consider a robo like Stash if you wish to invest in individual equities in addition to a pre-built portfolio.

If you’re looking for a thorough financial strategy, consider the following: Robo-advisors excel at constructing ETF-based portfolios. You’ll undoubtedly want a typical financial adviser if you want assistance on your complete financial life, including suggestions for goods like insurance or estate planning services.

Have a difficult financial position: A traditional financial adviser is the best option if you need assistance dividing assets after a divorce, have a complicated tax situation, have a lot of debt, or need help budgeting for education and end-of-life needs.

Keep in mind that you may need to speak with various sorts of financial specialists even if you have a financial adviser. You may find yourself in a position where you need the services of a tax advisor or an estate planning attorney. The more complicated your finances are, the more likely you are to need the assistance of a specialist financial adviser or wealth planning team.

Final Thoughts

When you’re just getting started and want a straightforward approach to start developing your money, a robo-advisor might be a fantastic option. However, when your net worth grows and your position gets more complicated, you may need to hire a human financial counselor to guide you through your financial destiny.

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