From smart homes to self-driving cars, technology is redefining and streamlining the way we live. Even the way you invest your money is getting an upgrade. Robo-advisors are adding the benefits of automation to your finances by helping you build and manage an investment portfolio with ease.
But what is a robo-advisor? And should you be using one? This guide answers those questions and dispels some of the myths surrounding this new type of investing.
What is a robo-advisor?
In a nutshell, a robo-advisor is an investment offering that combines human smarts with digital efficiency and convenience. It uses computer software and unique algorithms to build diversified portfolios for the investors.
Compared to working one-on-one with a human investment advisor or trying to build a DIY portfolio, robo-advisors allow you to take more of a hands-off approach to investing while skirting the big fees.
How does a robo-advisor work?
It’s fairly simple to invest using a robo-advisor.
You tell the robo-advisor your investing goals, how much risk you’re comfortable taking on, and your timeline for investing. The platform then creates an investment portfolio for you that’s designed to fit your needs.
Some robo-advisors, like Ally Invest’s Managed Portfolios, take investment management a step further and offer features like automatic rebalancing and tax optimization. Some robo-advisors even offer tax-loss harvesting.
Rebalancing helps to keep your portfolio’s asset allocation in line with your goals. Tax loss harvesting is a way to minimize the amount of tax paid on capital gains in your portfolio. (Capital gains tax applies to profits earned on your investments.) Your portfolio building, robo-advisor rebalancing, tax optimizing, and tax loss harvesting are done using a combination of human input and technology to make the process as efficient as possible.
How much money do you need to invest using a robo-advisor?
One good thing about robo-advisors is that you don’t necessarily need a substantial amount of investable assets to start building a portfolio.
Some robo-advisors, for instance, set a high threshold, expecting you to have $5,000 or more to invest. But others have no minimum deposit requirements to open an account and start investing. Of course, until you fund your account with something, you can’t start to earn market returns.
You have the flexibility to choose which advisor you want to work with. You can start investing in our automated, professionally-managed Managed Portfolios with just $100.
Regardless of how much or how little you start with, robo-advisors typically make it easy to add to your investments. You can link a bank account and set up recurring automatic transfers into your investment account so your portfolio can keep growing on auto-pilot.
How much does it cost to use a robo-advisor?
One of the greatest innovations robo-advisors has brought to investing is in how inexpensive they’ve made it to get invested.
Compared to other more traditional investment advisory options, robo-advisors tend to offer a cheaper path to investing by charging far lower and far fewer fees for their services than human advisors. Instead of collecting a commission or trading fees, plus a management fee, robo-advisors will often charge a single fee to manage your account.
This fee could be a flat dollar amount or a percentage of investable assets in your account and could be charged monthly or yearly. Typically, the cost of using a robo-advisor ranges from 0.2% to 0.5% of your account balance, compared to human portfolio managers who may charge a 1% to 2% advisory fee for their services. And Ally Invest now offers a Managed Portfolio with a cash buffer that has no advisory fees!
Robo-advisors can also help keep costs down when it comes to what you invest in. Many build diversified portfolios that consist of exchange-traded funds (ETFs), which are low-cost funds that trade on an exchange like a stock.
Many ETFs offer low expense ratios, which is the annual management fee you pay to own the fund. ETFs can also have lower turnover rates (a.k.a. how often the assets within the fund are bought and sold) compared to traditional mutual funds. When fund turnover is low, fewer opportunities exist for capital gains tax to be triggered.
That’s something you want if you’re investing in a taxable brokerage account. Offering ETFs, along with automatic tax loss harvesting, are two ways robo-advisors aim to keep investor portfolios as tax efficient as possible.
What are the benefits of using a robo-advisor?
There are several reasons to consider using a robo-advisor and most of them can be traced back to one thing: convenience.
When you let a robo-advisor choose your investments, it eliminates the headaches of trying to create a diversified portfolio on your own. You don’t have to be a stock or investing expert to use a robo-advisor. The platform uses the information you provide about risk tolerance and financial goals to present you with a balanced investment portfolio that aligns with those needs.
Another important benefit is automatic portfolio rebalancing. The purpose of rebalancing is to keep you from becoming too heavily weighted in any one investment or sector. If you own too much of one stock or mutual fund or market sector, it can increase your risk factor. For example, if 50% of your portfolio is concentrated in high growth stocks, you could experience a major loss if several take a nosedive. Rebalancing can help you avoid that kind of financial nightmare.
Besides that, robo-advisors can also offer other tools to help you manage your investments, like access to retirement calculators or a library of financial planning-related articles.
Is there any human element about a robo-advisor?
One misconception about robo-advisors is that they’re completely digital. But that’s not necessarily the case.
While computer software programs do some of the work when it comes to portfolio management, more comprehensive robo-advisors, like Ally Invest’s, employ human financial professionals, as well, to oversee portfolio recommendations.
This makes robo-advisors a hybrid that offers the best of both worlds. You get the convenience of a technology-enabled process, along with access to a traditional financial advisor — but without the typical costs.
How do you decide if a robo-advisor is right for you?
Robo-advisors may be better suited for some investors than others. To determine if using one is the right move, consider how much time and effort you can put into investing and what you hope to get in return.
If you’re new to investing and want to make building a portfolio as simple as possible, with minimal costs, then a robo-advisor can help you do that. On the other hand, if you’d prefer more control over what goes into your portfolio, you might be better off with a self-directed brokerage account instead. In this type of taxable account, you pick and choose which investments (stocks, bonds, ETFs, options, etc.) you’ll use to grow wealth.
Technology can make our lives easier, but it’s up to you whether or not you want to make it a part of your investment strategy. If you do, a robo-advisor could be the solution you’re looking for.