A robo advisor is a computer program that manages client investments automatically based on a preselected strategy. Robo advisors make investment decisions based on algorithms rather than input from humans, who can react emotionally or make mistakes. Robo advisors are also typically much less expensive than traditional financial advisors, making them ideal for cost-efficient, automated investing.

What a Robo Advisor Is

A robo advisor is an automated investment service that manages client portfolios using complex computer models. This is different from a traditional investment advisor who provides personal advice or makes decisions on clients’ behalf. Some robo advisors have licensed professionals who provide guidance to clients, but robo advisors rely on computer-driven systems to manage client investments.

Some investments used in automated robo advisor strategies include:

• Stocks: Share in individual companies that trade on exchanges
• Bonds: Debt issued by countries or companies
• Mutual funds: Portfolios of stocks and/or bonds that are professionally managed
• Exchange-traded funds (ETFs): Baskets of stocks or bonds that are structured like mutual funds but trade like stocks

Robo advisors are both independent firms that specialize in automated investing strategies as well as product lines for larger investment groups. In either case, robo advisors are platforms that developed to understand a client’s individual circumstances and investing needs and match investors with the proper trading strategy, which then manages the client’s account without human involvement.

Robo Advisors vs. Traditional Financial Advisors

A financial advisor is a licensed professional who helps clients build and execute long-term financial plans based on their individual needs and objectives while a robo advisor is an automated investing system that can be used by investors who are comfortable with technology instead of getting individual guidance.

Typical financial advisors work with clients to understand their needs and build individual investment strategies that can be altered as circumstances change. Financial advisors usually schedule periodic reviews to review and update client accounts as necessary. Using a robo advisor, clients eliminate much of this human element to financial planning.

Investors who use robo advisors start by completing a questionnaire. The robo advisor then uses this information to recommend one or more investment strategies that may be a good fit for the client. An investor decides on his or her own whether to use those strategies, which are managed automatically by the robo advisor. If an investor’s circumstances change, it’s up to them to redo their questionnaire or change investment selections as necessary.

“The human element of an advisor interaction is a key component to addressing an investor’s individualized goals and challenges and provides ongoing behavioral coaching. Our research demonstrates that cogent wealth management can add about 3 percent in net returns for investors. Of course, investor preference may be for face-to-face interactions and, for those individuals, consulting with a local, independent advisor can be a great solution.”

— Tim Stokes, Company Spokesperson, Vanguard

Robo advisors don’t create client-specific strategies. Instead, clients must understand their own circumstances — sometimes with the help of tools from the robo advisor — and decide on a preset strategy that’s right for them. Because these strategies are automated, robo advisors typically have smaller minimum account sizes that traditional investment advisors.

“One of the biggest differences between robo advisors and traditional financial advisors is that you can start investing and planning with any amount of money. Many human advisors won’t even consider taking on a client with less than $100,000 to work with. For this reason, robo advisors are becoming popular with people in their 20s and 30s who haven’t built up a ton of wealth yet. Robo advisors are generally much cheaper and more accessible than a traditional human financial advisor. However, they usually won’t be able to answer your specific financial questions or give real-life advice like a normal financial advisor.”

— Brin Chartier, Director of Marketing, LearnLux

Who Robo Advisors Are Right For

While traditional financial advisors help clients understand their individual needs, robo advisor clients should be able to understand their own circumstances and objectives without the help of an advisor. When asking “should I use a robo advisor,” investors need to think about whether they know enough about investments to determine what they want.

Four types of investors who should consider using a robo advisor include:

• Sophisticated investors: Investors who have developed an understanding of how accounts and investments work
• Account consolidators: Savers who have already built a portfolio and want to consolidate accounts into one or more automated investing strategies that they can review
• Tech-savvy investors: People who are comfortable with technology and want to use it to manage their money according to prearranged strategies
• Cost cutters: Investors who are willing to learn about finance so they can save money over the long-term with robo advisor fees rather than traditional investment management costs
• Smaller investors: Investors who haven’t yet built a large portfolio can have an easier time getting started with a robo advisor because minimum account sizes are typically smaller

While there are many investors who should consider using robo advisors, there are many others for whom a robo advisor isn’t appropriate. These include investors who don’t know much about investing or need individual guidance from a financial advisor to understand their needs or determine what investing strategy to use.

Some investors who shouldn’t use a robo advisor are:

• Inexperienced investors: People who haven’t spent time studying markets and need individual help to pick investments and strategies
• Uber-wealthy: Wealthy individuals and families often utilize complex tax- and estate-planning strategies that aren’t available from robo advisors
• Nontech savvy: If you aren’t comfortable using technology to guide your investments, a robo advisor isn’t for you

“Robo advisors place the onus of responsibility on the investor to understand what’s happening with their portfolio. They have to do the reading, they have to work through the fine print, and there’s nobody there to help them explain what’s happening. For someone who is financially savvy, that’s great. They don’t need any hand-holding. But, for someone who wants to use a robo advisor as part of an overall financial plan that addresses not only their investments but other aspects of their financial life, a robo advisor isn’t going to provide solutions. This is where the services of a financial planner or an independent financial advisor can be crucial.”

— J.R. Duren, Personal Finance Analyst, HighYa.com

Best Robo Advisors

Five of the best robo advisors are:

1. Wealthfront

Wealthfront is one of the best and most-established robo advisors available. It offers access to one of the broadest ranges of investments and charges just 0.25 percent to manage an account, one of lowest robo advisor fees available. Wealthfront manages accounts as small as $500 and also offers great additional features including tax strategies and the ability to borrow against a portfolio.

2. Betterment

Betterment is a robo financial advisor that offers four different investment strategies including:

• Socially responsible investing: Investing heavily in companies that meet certain environmental or corporate standards
• Goldman Sachs Smart Beta: A diversified strategy designed to outperform the broader market
• BlackRock target income: A bond-focused strategy designed to provide income and eliminate market volatility
• Flexible portfolios: Account holders with more than $100,000 can customize their own portfolios

Each of Betterment’s investment options are cost-efficient and can be used alone or in combination. Betterment also offers up to a free year of account management with qualifying deposits and has a team of dedicated professionals to help investors who need individual guidance for an extra fee.

3. Motif Investing

Motif Investing is a provider of automated, technology-driven investment strategies. Motif Investing manages about half a billion dollars using investment strategies that follow different themes, which are ideal for investors who want to invest in certain long-term trends or growing industries. Motif Investing is also the only robo advisor we’ve found that helps investors participate in initial public offerings (IPOs).

4. Vanguard

Vanguard is the largest mutual fund company in the world and is the first of the robo advisors to surpass $100 billion in assets under automated management. Vanguard’s robo advisor focuses on providing a strong selection of cost-efficient mutual funds and ETFs to passive, cost-conscious investors. It’s an ideal robo advisor for investors who fit this description.

5. TD Ameritrade

TD Ameritrade is another firm that recently started its own automated investing service. TD Ameritrade Essential Portfolios only offers five automated trading strategies with no option for customization, making them the best robo advisor for simplifying investment selection. TD Ameritrade’s also good if you want to use some of the firm’s other services including banking in the U.S. and Canada.

When deciding between robo advisors, there are a number of factors to consider including investment options, robo advisor fees, account minimums and additional features. However, if you start with a robo advisor and find that it’s not ideal, you can always change later. For more information on the best robo advisors and how they help clients be sure to check out our full list of the best robo advisors.

Robo Advisor Fees

One of the biggest advantages of robo advisors is that its cost is typically lower than those of a traditional financial advisor. If you’re investing $100,000 or more, robo advisor fees can provide more than a thousand dollars in savings each year. Most robo advisors charge small management fees, but commissions may apply based on trading activity.

Typical robo advisor fees may include:

• Management fee: 0.2% – 0.5% annually
  Most robo advisors charge a fee for managing client accounts based on the number of assets in an account.
• Fund expense ratio: 0.06% – 0.50% per year
  Funds available through robo advisors all charge their own expense ratios to cover the costs of trading and management, but most robo advisors only give investors access to low-cost funds.
• Trading commissions: $0 – $50 per trade
  Not many robo advisors charge trading commissions, but those providers that offer investors access to more investment options or offer additional features sometimes charge for trades.
• Platform fee: $50 – $250 per year
  Some advisors charge a fee for investors to access their platform, but this is usually only for robo advisors that are focused on trading rather than passive investing. Some robo advisors also charge for premium features or additional trades.

“A robo advisor can provide some investors with low-cost asset allocation and portfolio rebalancing services, but without human support are not as good as a human advisor at things like helping set personal goals, doing financial planning or dealing with the emotional aspects of market volatility as a traditional human advisor. They’re actually very complementary in many ways, which is why the conversation in the industry has largely shifted away from robo vs. human to how do they work together to optimize service efficiency and effectiveness.”

— Mike Foy, Senior Director for Wealth Management, J.D. Power

Pros & Cons of Robo Advisors

Investors can use robo advisors alone or as part of an overall financial plan. While robo advisor fees are typically lower than a traditional financial advisor, it’s important to consider robo advisor pros and cons before deciding whether a robo advisor is right for you.

Pros of a Robo Advisor

Some robo advisor positives include:

• Lower cost than a traditional money manager: Robo advisor fees are usually lower than those of a traditional investment advisor
• Objective decision-making: Robo advisors remove the human element from investing, so your portfolio isn’t subjected to emotional decision-making or human errors
• Less paperwork: Setting up an account with a robo advisor is usually faster and easier than setting up an account at a traditional investment advisor
• No reliance on a financial advisor: Once you set up a robo advisor account, you have control; you don’t need to wait for a financial advisor to make changes to your account — if you don’t like the strategy you’re using, you can change at any time
• Lower minimum investment: You can open an account at a robo advisor with less money than is usually needed to work with a traditional financial advisor

Cons of a Robo Advisor

Some of the negatives of using a robo advisor include:

• No personalized guidance: If you use a robo advisor instead of a traditional financial advisor, you won’t have anyone to help you plan for life events, understand your needs or objectives or make financial decisions
• Systems can be taken advantage of by outsiders: Many algorithms that robo advisors use can be taken advantage of in financial markets; other traders can learn their patterns and trade systematically to make money from robo advisors’ automated systems; it’s this kind of activity that led to the flash crash in 2010
• No review of trading strategies: Automated investing systems used by robo advisors are proprietary,, so you don’t have the opportunity to test a system and see how it works or know its weak points

Robo advisors can have some considerable drawbacks if used alone. However, when used in conjunction with a traditional financial advisor, a robo investment advisor can be a great, cost-effective tool for managing part of a portfolio. Investors still get the individual guidance of a personal financial advisor and can decide how much of their portfolio can be managed using automated strategies.

“The most prominent area where the algorithms of robo advisors fail is at helping clients explore and prioritize competing goals within their financial plan. This is especially problematic for small business owners who have competing goals within their personal and business finances and also have the challenges of balancing priorities between personal and business financial plans.”

— Joshua Escalante Troesh, Founder, Purposeful Strategic Partners & Professor at El Camino College

Tips for Using a Robo Advisor

If you think that a robo advisor may be right for you, there are several tips to keep in mind as you research robo advisors. There are other factors to consider as you narrow down your list, choose an advisor and select the investment strategy that’s right for you.

When considering a robo advisor, some tips from the experts include:

Research Strategies Before You Choose a Robo Advisor

Robo advisors have different focuses and strong suits. If you’re going to use a robo advisor, it’s up to you find the strategy that’s right for you. This starts with research advisor-specific strategies and considering each in light of your circumstances, including your individual needs, objectives and risk tolerance.

Most robo advisors are geared toward cost-efficient, passive investing in mutual funds or ETFs, while others facilitate active trading. Some robo providers help clients with specific tax strategies. A few even offer access to IPOs. When you’re researching robo advisors, be sure to make note of the features that might benefit your investing strategy.

Understand the Terms of Your Robo Advisor Agreement

After you research robo investment advisor strategies, be sure to consider the fine print for each provider. Make sure you understand not just their investment strategy but also their account minimums, expected volatility, availability of customer service and ease of account access. Many of these factors will help determine which robo advisor is right for you.

“There are services that allow investors to set up a small account for free, which is great for folks who want to try it out. Also, if you’re uncomfortable with turning over investment decisions to a machine, there are non-automated flavors or robo that will just make allocation recommendations that you must approve to execute.”

— Mike Foy

Decide on the Right Robo Advisor Fee Structure

Before deciding on a robo advisor, be sure to compare the fees for your potential advisor to alternatives including other robo advisors and traditional financial advisors. It’s also worth comparing robo advisor costs to fees for target-date funds, which are mutual funds that automatically shift from stocks to bonds as a target retirement date approaches.

Some fee structures for robo advisor alternatives include:

• Target date funds: 0.10% – 0.75% of amount invested
  Target date funds charge an annual expense ratio that covers the cost of the management and trading for the fund; depending on how you invest, you may also be charged commissions to purchase shares in a target date fund
• Personal investment advisor: 0.50% – 2.00% of account balance
  Traditional investment advisors typically charge a management fee for advising or managing your account; fees are typically based on the size of your account and vary by advisor
• Traditional broker: up to 6% of account balance
  Personal financial advisors can be compensated a number of ways, but they often collect commissions on trades or mutual fund purchases; these costs can quickly reach 5 to 6 percent of your account balance if you aren’t careful

Robo advisor fees are typically structured based on their investment strategy — robo advisors focused on passive investing usually charge a management fee while a trading-focused provider will likely charge commissions for trades or rebalancing.

Understanding your prospective robo advisor fees is important for a number of reasons. These fees can add up over time, so it’s important to know what you’re paying for to get maximum value for your money. It’s also important to know how your fees will be structured so you don’t run up large charges unintentionally.

Test the Waters with a Robo Advisor Account

Once you’ve decided to use a robo advisor that offers the right investment strategy and appropriate robo advisor fees, you have to set up an account. However, it’s typically not a good idea to rush into automated investing with all your savings. Instead, start out small and see whether a robo advisor works for you. You can always add to your account later.

Establishing a robo advisor account is typically very easy once you know what you want. The important part is understanding your circumstances to ensure that your robo advisor is consistent with your individual needs and objectives.

Robo Advisor Frequently Asked Questions (FAQs)

If you’re thinking about using a robo advisor and still have questions, here are some of the most frequently asked questions about robo advisors and their strategies. If you still don’t see an answer to your question, feel free to post your question in the comments section or visit the Fit Small Business Forum.

What Is Tax Loss Harvesting?

Tax loss harvesting is a tax strategy offered by some robo advisors that can boost investors’ after-tax returns over time. Using tax loss harvesting, you sell investments that have declined in value so that you can use the capital loss generated by the sale to offset capital gains or interest income in your portfolio.

What Is Socially Responsible Investing?

Socially responsible investments are investments in companies or other entities that operate in certain industries or act in certain ways. Some robo advisors offer socially responsible investments in support of things like corporate responsibility, sustainability or fair labor practices.

Are Robo Advisors FDIC-insured?

Robo advisors are investment accounts, not bank accounts, so they do not offer Federal Deposit Insurance Corporation (FDIC) protection. Investors can lose money with robo advisors the same way they can with any other brokerage firm or investment advisor.

The Bottom Line

A robo advisor is a financial service provider that specializes in offering automated investing strategies. These strategies are computer-driven and remove most of the human element from investing. Robo advisor fees are typically lower than traditional financial advisor costs, but there are many factors to consider when deciding if a robo advisor is right for you.