If you're a young, aspiring investor, choosing a robo-advisor to manage your money could be the easiest way to get started without breaking the bank.
"Robo-advisor" is a nickname for online money management services such as Betterment, Wealthfront and others. These services guarantee you a highly diversified portfolio with little maintenance required on your part.
Robo-advisors might be right for you if you:
- Are looking for low-cost alternatives to traditional investment options
- Don't have the time to devote to managing your portfolio
- Don't have much interest in learning how to invest in individual stocks
- Are not planning to invest large amounts of money
- Are comfortable with having your money managed automatically
- Are not interested in high-risk investments or trying to time the market
These services invest primarily in exchange-traded funds (ETFs). They also provide services beyond asset allocation that may include account maintenance, tax-loss harvesting, automatic dividend reinvestment and periodic portfolio rebalancing.
Robo-advisors are considered low risk because they use a passive investing strategy -- trading infrequently and not relying on market timing.
Online money managers differ in cost, features and unique offerings. Here's what distinguishes one robo-advisor from another:
Robo-advisors are less expensive than traditional models, but each site has different minimum balance requirements. For example, Betterment doesn't have any account minimums. Wealthfront recently lowered its account minimum from $5,000 to $500.
Accounts with higher minimums, typically up to $100,000, will include additional services or perks. Other providers fall somewhere in the middle -- for example, Charles Schwab's Intelligent Portfolios requires a minimum $5,000 investment.
Each ETF you invest in through a robo-advisor will have its own expense ratios -- the annual charge to cover the fund's expenses. For example, expense ratios for Betterment ETFs typically fall in the range of 0.09% to 0.17%; for Wealthfront ETFs, the average is 0.12%. Schwab's Intelligent Portfolios, meanwhile, can have ETFs with ratios from 0.04% to 0.48%. The advising platform you choose might also have fees of its own.
Some tools, such as Schwab's Intelligent Portfolios, won't tack on advisory fees, commissions, trade fees, account service fees or annual fees. Other robo-advisors charge additional costs for management, usually a percentage of account balances.
Betterment, for example, may not have a minimum account balance, but it does charge $3 per month for accounts with a balance of $10,000 or less that do not have an automatic deposit of at least $100 per month. Its fee structure depends on the account balance: a 0.35% annual fee for accounts of $10,000 or less with a $100 minimum monthly auto-deposit; a 0.25% annual fee for accounts between $10,000 and $100,000; or a 0.15% annual fee for accounts of more than $100,000.
Wealthfront, on the other hand, will manage your first $10,000 for free and the rest for an annual fee of 0.25% on your assets over $10,000.
Asset classes refer to investments with similar characteristics, such as large-company stocks or international bonds. Not all robo-advisors offer the same number or type of asset classes. Wealthfront and Betterment, for example, both use ETFs that track indexes for up to 11 asset classes. Schwab, meanwhile, offers 54 ETFs that represent 11 fund families and 20 asset classes.
Your portfolio will need to be rebalanced periodically to keep your asset allocation in line with your goals and risk tolerance. Not all robo advisors offer automatic rebalancing; some may have additional requirements to unlock this feature.
Tax-loss harvesting refers to offsetting taxable gains by selling securities that have experienced a loss. The security that has been sold is then replaced by a separate, similar security. Wealthfront, for instance, offers free daily tax-loss harvesting for all taxable, non-retirement accounts. Schwab clients, on the other hand, must have an account balance of at least $50,000 to qualify for tax-loss harvesting.
Additional features and perks can set one online advisor apart from another. The types of retirement and non-retirement accounts offered will vary across different models. Depending on your account balance, you might qualify for premium levels at some robo-advisors. Tax optimization features will also vary from service to service.
Each money management service takes a different approach. Wealthfront, for example, streamlines its focus into each separate account, such as taxable investment accounts or retirement accounts. Betterment, on the other hand, frames each account according to goals, such as safety net or major purchase. The goals enable users to understand how their accounts are organized in a consumer-friendly framework.
Other features that will differ from platform to platform include dashboards, mobile apps and questionnaires.
The level of interaction with real people varies across robo-advisor platforms. All offer basic phone and online customer support. Schwab's Intelligent Portfolios offers live help from investment professionals anytime.
Some accounts offer a higher level of one-on-one service at a higher cost. Vanguard Personal Advisor Services requires a $50,000 account minimum, and Personal Capital has a $100,000 account minimum. Both Vanguard and Personal Capital offer the benefit of one-on-one consultation from real advisors, albeit at a significantly higher cost than other robo-advisors. Of the two, Vanguard is less expensive with a fee of 0.30% compared with Personal Capital's 0.89%.
Betterment customers can schedule a one-time personal consultation with a financial planning expert, but only if they have an account balance of $500,000 or more.
For the novice investor, robo-advisors are probably the cheapest, simplest way to invest. Robo-advisors' fees are structured to cost much less than traditional advisors, which charge around 1% or more each year to manage your investments. Still, finance professionals say online services are no substitute for the advice of a real person.
As your finance needs change, a financial advisor will be able to adapt and counsel you through more complex situations, says Steven Elwell, a Certified Financial Planner and vice president at Schroeder, Braxton and Vogt in Amherst, New York. "Life is too complicated to be able to provide that type of advice in a mass way through software because there are just too many variables," he says.
Elwell likens online investing tools to tax preparation software. "The tax code is just a set of rules that was turned into software that can help people with really simple situations, but the accounting industry has not disappeared," he says. "Even with a base set of rules that should be black and white, there are still scenarios software can't predict that you'd want to use an accountant to strategize about the best thing to do." Online money management services are most useful for people with straightforward investment goals, he says, but they won't replace the need for financial advisors in the long-run.
Still, even advisors acknowledge that for a first-time investor, a robo-advisor is a good, low-cost starter solution.