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Robo-advisors could be a good alternative to managing your own investments or hiring a financial advisor, but they're not a great fit for everyone or every situation. Consider the advantages and disadvantages before opening an account and investing.
What is a Robo-Advisor?
Robo-advisors are automated investment platforms that offer a hands-off approach to managing your investments. When you sign up for a robo-advisor, you generally fill out a questionnaire that asks about your personal and financial information. You can also choose a goal for your investment account and answer questions about your comfort level when it comes to investing risk.
Based on your responses and the way the platform works, the robo-advisor may suggest a mix of investments or one of its premade portfolios. The robo-advisors will then often invest your money in exchange-traded funds (ETFs) and mutual funds, which can be a low-cost way to diversify your holdings.
Robo-advisors also handle the ongoing management of your portfolio. For example, they'll periodically rebalance your portfolio—buying and selling investments to adjust your asset allocation and maintain a steady balance between risk and reward.
| Pros | Cons |
|---|---|
| Often less expensive than working with a professional financial advisor | More costly than doing it yourself |
| Easy to start and may have a low account minimum | Could take a narrow view of your investments or financial situation |
| Includes ongoing management | Limited personalization |
Advantages of Robo-Advisors
Many people trust a robo-advisor with their money, and some companies are even using them to manage employees' retirement funds. There are several reasons you may want to invest with a robo-advisor as well:
It's Easy to Get Started
Starting to invest can be difficult. You may need to save up until you meet an advisor's or mutual fund's minimum balance requirement. Or, you might have enough money, but not be sure where to put it.
Some robo-advisors have low (or no) minimums, and they'll make suggestions based on your responses to the questionnaire. You can also open taxable investment accounts and tax-advantaged retirement accounts, such as an IRA, with many robo-advisors. And some platforms support joint accounts and a trust account.
Hands-Off Management
When you're investing with a personal account or a retirement account through work, you may be responsible for watching and managing your asset allocation. Robo-advisors automatically rebalance your portfolio based on your goals and risk tolerance. You also may be able to update your goals or risk level, and your portfolio will be adjusted accordingly.
Relatively Low Management Fees
Most robo-advisors charge a fee based on how much money is in your account. It can vary depending on the platform and the balance, but often ranges from about 0.25% to 0.89% per year. In comparison, a human financial advisor may charge 1% to 2%. The ETFs and mutual funds you're invested in may also charge a fee. These don't depend on how you buy the fund (on your own or through an advisor, for example), but you may want to review the robo-advisors' fund choices to compare which option has the lowest combined fees.
Tax-Loss Harvesting
Some robo-advisors offer tax-loss harvesting as a feature. When enabled, the robo-advisor can sell losing investments to "harvest" tax-deductible capital losses and then buy other investments that will keep your portfolio on track. The strategy could save you money this year and may lead to higher long-term gains.
Drawbacks of Robo-Advisors
There are also a few reasons why a robo-advisor might not be a good fit for you:
Limited Access to Human Advisors
Some robo-advisors only offer human support for tech- and account-related questions, which means there's no one to answer questions about your investments. Others have a hybrid model which may give you access to human advisors. However, you may need to reach a minimum account balance or pay higher management fees, and you won't necessarily have a dedicated advisor.
Narrow Investment Choices
You might not be able to choose (or avoid) specific investments when you use a robo-advisor. Even among the ones that let you customize the investments or allocation within your portfolio, you may still be limited to a list of preselected funds. And while some platforms offer socially responsible options, that can mean different things to different people.
Might Not Consider All Your Investments
The robo-advisor can suggest and manage your account based on the information it has, but it won't necessarily have a complete picture of your other assets and investments. While some platforms let you connect all your financial accounts, you still might not receive the same level of personalized advice that you would with an advisor who understands the complexities of your financial situation.
Tax-Loss Harvesting Isn't Always Helpful
While tax-loss harvesting could help increase your overall returns and lower your tax bill this year, it's only potentially helpful if you're using a taxable account. Additionally, you need to be aware of the wash sale rule. If you buy a substantially identical security within 30 days of your robo-advisor selling a security, even if you buy it in a different account, you can't claim the capital loss this year.
Should I Use a Robo-Advisor?
If you want help choosing and managing your investments, but don't want to pay for a financial advisor or don't meet an advisor's minimum balance requirement, a robo-advisor could be a good option.
You'll still want to do research, though. There are different robo-advisor services available, and you can compare the options, features and fees to decide which may be best based on your goals and how you plan to use the account. You can also read reviews of specific services to learn how others feel about the usability, support and performance.
In some situations, a robo-advisor might not be the best option. For example, you might not want to use a robo-advisor if you want to pick specific investments or individual stocks. A robo-advisor also might not be a good fit if you want to build a long-term relationship with your financial planner, have a complex financial situation or if you have a high net worth and could benefit from more personalized investment and tax advice.
Prepare Your Credit
Regardless of how and where you invest, having good credit can be an important part of your financial health. Whether you're paying down debt or looking to take out a new loan, a good credit score could make the process easier and may save you money. You can check your credit score for free and sign up for credit monitoring through Experian to get insight into what's having the greatest impact on your score.