A robo-advisor is a digital platform that delivers automated, algorithm-driven financial planning and investment services with minimal human intervention. They were introduced nearly a decade ago, and with numerous options now available, robo-advisors have revolutionized the investment landscape. They’re gaining popularity among both novice and experienced investors due to their ease of use, low fees, and automated features, such as portfolio rebalancing and tax-loss harvesting.

What is a Robo-Advisor?

A robo-advisor is an online platform that creates automated portfolios based on a user’s financial situation and investment goals. Typically, the process begins with a questionnaire assessing the user’s risk tolerance and investment needs, which can range from retirement planning to buying a new car.

The robo-advisor then uses this data to build a diversified portfolio of funds, usually selected by a team of investment professionals. A sophisticated algorithm ensures your portfolio is appropriately rebalanced, and some robo-advisors even include access to a live consultant or financial planner for additional guidance.

Robo-advisors are excellent at navigating between personal preferences, such as time horizons, financial goals, and risk tolerance, and unpredictable market conditions to recommend portfolios that fit the investor’s specific needs.

How Do Robo-Advisors Differ from Traditional Advisors?

There are three key approaches to investment advising: robo-advisors, traditional advisors, and a hybrid model combining both.

Robo-advisors are ideal for a single investment goal, offering automated portfolio rebalancing and generally lower fees. However, they typically do not provide access to financial planning advisors.

The hybrid model blends robo-advising with professional guidance, giving investors access to an online planning tool and an advisor via video chat. This approach comes with moderate fees.

Traditional advisors, on the other hand, are suitable for more complex services such as estate planning. They offer personalized attention, in-person meetings, and holistic financial assistance, but typically at higher fees.

Top Robo-Advisors

Betterment – Touted as the best robo-advisor overall by various customers and reviewers, Betterment is recognized for its competitive annual advisory fee and the ability to choose different portfolios for different goals. It provides tax management features, including tax-loss harvesting, although accessing professional advice comes with a relatively high fee.

Vanguard Digital Advisor – This platform is a great choice if you are a beginner, offering ultra-low-cost fees, excellent retirement planning tools, and a simplified investing approach. However, it requires a minimum of $3,000 to get started and does not provide access to financial advisors.

SoFi Automated Investing – Known for its low fees, SoFi Automated Investing does not charge an annual advisory fee and only requires $1 to get started. Although it offers access to financial advisors at no additional cost, its relatively short track record and the use of its own in-house ETFs may be a concern for some investors.

Benefits and Limitations

Robo-advisors have several key benefits. They often automate and optimize passive indexing strategies based on modern portfolio theory, making them an excellent tool for traditional investing. They’re typically inexpensive and require low opening balances, making them accessible to retail investors.

However, they’re not the best options for more complex issues, such as estate planning, and they’ve been criticized for their lack of empathy and complexity. Also, as they are digital platforms, the level of personalized attention you can get from a human financial advisor is limited.

The Future of Robo-Advising

Assets managed by robo-advisors have grown from $47.3 billion in 2015 to an estimated $460 billion in 2022, indicating their growing popularity and the potential future direction of investment management. However, investors must weigh the pros and cons and decide which investment approach – whether robo-advisors, traditional advisors, or a hybrid model – best fits their individual financial needs and goals.