Robo investing has become increasingly popular as a low-cost, low-effort method to grow your wealth and save for big goals like retirement. With a robo-advisor, you don’t have to worry about the ins and outs of picking stocks or other investments – all the heavy lifting is taken care of automatically.
Is robo investing right for you? In this guide, we’ll cover everything you need to know about automated investing, from how it works to how to choose a robo investing platform.
What Is Robo Investing?
Robo investing is a type of investing that relies on an algorithm to invest your money. Typically, the goal of a robo investing platform is to help you build a diversified portfolio without requiring you to hire a financial advisor or become an investment guru yourself. Once you sign up for a robo investment platform, your money will be automatically invested with only minimal human supervision.
Just as different financial advisors have different approaches to investing, so too do different robo investing services. You can find platforms that are more or less aggressive with your investments and ones that offer investing in more than just basic stocks and bonds.
Robo investors will create a custom-tailored portfolio for you after learning more about your financial situation.
For example, here are two basic portfolios from the Acorns robo-advising app:
The portfolio allocation varies based on the account holder’s risk tolerance.
Why Use Robo Investing?
The primary advantages of robo investing are that it’s straightforward and relatively inexpensive. You don’t need to know much about the stock or bond markets to get started with a robo investing platform. Rather, you just need to answer some basic questions about your financial goals – such as whether you want to save money to buy a home, to retire, or both – and your tolerance for financial risk. The software will take it from there to decide how to allocate your money among investments and build a balanced portfolio.
You could get a similar service from a financial advisor. But, as you might expect, enlisting a human advisor is generally much more expensive than using an algorithm. Human advisors may take 1% of your total investment or more per year to pay their fees. Most robo investing services, on the other hand, charge less than 0.5% per year.
Who Should Use Robo Advisors?
Robo investing can be a good approach to investing for a wide variety of people. This type of investing is particularly well-suited for people who want to set and forget their investments. A robo advisor will not only help you get started but will keep your portfolio on track without any input from you. Many younger investors, as well as busy professionals who don’t have time to manage their investments, prefer robo investing for this reason.
The Downsides of Robo Investing
On the other hand, robo investing is not ideal if you want a highly specific investing strategy. Most robo advisors only offer access to funds, not individual stocks, and they tend to take a buy-and-hold approach rather than a more active trading approach.
Robo advisors also cannot replace human, financial advisors in some cases. If you have multiple investment accounts and need to coordinate with an employee benefits package, you will probably need more support than a robo investing platform can offer. Robo advisors also take something of a one-size-fits-all approach to investing – if you need more tailored financial advice, you might benefit from a human advisor.
How Do Robo Investing Platforms Work?
When you sign up for a robo investing platform, the software will generally ask you some questions about your investing goals and willingness to take risks. From there, the algorithm will recommend a balance of stocks and bonds or other assets and automatically invest your money to achieve that desired portfolio.
Over time, as you add money to your account and the value of your investments change, your portfolio may fall out of balance. Most robo investing platforms will automatically buy and sell assets in order to bring it back into line. They will also take this opportunity to offset any investing profits you have made with losses in order to minimize your tax liability (a process known as tax-loss harvesting).
Many robo investing platforms enable you to schedule automatic investments or to split your account into multiple portfolios that target different financial goals. If you set up a standard investment account rather than a retirement account, you can withdraw money at any time.
What Can You Invest In?
Most robo investing platforms only allow you to invest in exchange-traded funds (ETFs). These are baskets of stocks or bonds similar to mutual funds. The advantages of investing in ETFs are that they often have very low fees and can provide you with a diversified portfolio with just a few trades.
That said, some platforms will allow automatic investing in individual stocks based on your risk tolerance and interests. Others offer investing in real estate, typically through real estate investment trusts (REITs).
Here is an example of my account at Wealthfront that is comprised of a few different types of stocks and bonds:
How To Choose A Robo Investing Platform
There are a number of robo investing platforms available today, each with its own take on investing. Choosing which one is right for you comes down to a few factors.
First, what can you invest in? Does a platform only offer access to stocks and bonds, or can you invest in real estate and other assets? Even if your robo investing platform limits you to stock and bond ETFs, it is worth investigating what ETFs are offered. Consider whether you are only able to invest in US stocks or whether there are funds for emerging markets as well.
The degree of customization a robo advisor allows is also important. Some platforms only offer a couple portfolios – say, low, medium, and high risk. Others offer a handful of base portfolios but then allow you to customize the balance of stocks, bonds, and other assets as well as fine-tune your risk tolerance.
If there are specific market sectors that interest you or you want your portfolio to reflect your values, look for a robo investing platform that allows this. Some robo advisors have specialized portfolios for socially responsible investing, while others have portfolios that give extra weight to sector-specific ETFs.
When investing for the long term, it’s important to remember that small differences in fees can add up to a lot of money over the decades. Most robo advisors charge a percentage of your total account value. That percentage can be as low as 0.25% per year, or as high as 1% per year.
In addition, you will need to pay any fees associated with the assets your money is invested in. Most ETFs have exchange fees, which can range from 0.05% to 0.5%, depending on the fund. Look for robo investing platforms that offer low-cost Vanguard or iShares ETFs. Also, be sure to check whether your platform charges trade commissions to your account or whether buying and selling fees are included in your annual fee.
Best Robo Investing Platforms
To help you get started with robo investing, here are three of the top robo advising platforms on the market today. If you want to see how well they perform, check out this live case study where I put $25,000 to the test to see which robo-advisor could perform best.
Betterment looks and feels like a traditional brokerage platform, except your portfolio is automatically invested in low-cost Vanguard ETFs for you. This service enables you to choose how you would like to diversify your portfolio between stocks and bonds and encourages you to set automatic deposits to save for big goals like retirement. You can also create multiple “goals,” which are essentially self-contained portfolios for different purposes like buying a home or saving for your children’s college tuition.
Betterment charges an annual fee of 0.25%.
Wealthfront competes directly with Betterment on cost – this service also charges a 0.25% annual fee. But, the ETFs it invests in are significantly cheaper. Betterment ETFs charge exchange fees up to 0.40% per year, while Wealthfront’s most expensive ETF charges just 0.16% per year. Another plus to this service is that it includes a high-yield savings account.
That said, Wealthfront doesn’t offer much flexibility in choosing how your investments are balanced. So, this service is a good option if you don’t have a specific portfolio balance in mind.
Acorns is a good choice for people who want to invest and save for big goals like retirement without thinking about it. This service automatically rounds up your debit card purchases to the nearest dollar and deposits the spare change in your investment account. From there, Acorns will automatically invest your money in low-cost ETFs from Vanguard and Blackrock based on your chosen investing style. Of course, you can also set up larger, recurring deposits as needed.
Acorns charges a flat fee of $1 per month for standard investing accounts or $2 per month for IRA accounts.
Alternatives to Robo-Advisors
Robo-advisors are a great option for people who want to take a simple approach to their investment strategies. While you can rely on automated portfolios, you can also choose to work with traditional stock advisors.
Whereas robo-advisors automated the entire investing process, traditional stock advisors will give you investment advice that you can follow. For example, Motley Fool, our top-rated stock advisor, provides two stock picks every month. Subscribers receive alerts for these stock picks and can choose to purchase those stocks in their brokerage accounts.
There is a little more work involved since you need to manage the buying and selling yourself, however, these individual stock picks tend to outperform the automated portfolios offered by most robo-advisors. Stock advisors are most suitable for investors who want exposure to individual stocks. These stock investments tend to have higher growth potential but may be riskier as well. That said, most of these picks have considerably outperformed automated portfolios over the past decade.
The chart below offers a great illustration of how Motley Fool’s stock picks performed relative to the S&P 500.
Compare that to the performance of Betterment’s “100% stocks” portfolio, and you will see that the Stock Advisor program significantly outperforms the robo-advisor portfolio.
You can also choose to create both automated portfolios and portfolios built around stock recommendations. You can divide your funds across multiple accounts to take advantage of both investment strategies.
Conclusion: Robo Investing
Robo investing is a stress-free, low-cost way to invest your money. While this approach to investing isn’t right for everyone, it can be a very good alternative to managing your money yourself or hiring a human, financial advisor. When choosing a robo investing service, be sure to look closely at how your money will be invested, how much control you will have over the process, and how much you will pay for your investments over time.