What is a robo-adviser?

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Robo-advisers have become tremendously popular over the last decade, and rightly so. They automate the investing process for you, making it simple to invest in a diversified portfolio of assets, and they charge much less than a typical financial adviser. So it’s little wonder that many investors have turned to them, and robo-advisers now manage hundreds of billions of dollars.

Here’s what a robo-adviser does and who the major players are, including a few hiding inside some of the big financial institutions you already know.

What a robo-adviser does

A robo-adviser is really just a fancy term for a financial adviser that automates the process of investing and financial planning. A robo-adviser uses the planning tools that a human adviser would use and crafts a portfolio based on your risk tolerance and when you need the money.

But a robo-adviser does things that would be tedious, expensive or impossible for a human adviser to do. For example, robos automate the process of tax-loss harvesting so that you’re maximizing any taxable losses, even on a daily basis. It can also rebalance portfolios so your asset allocation stays on track. Other robos may provide further services, such as advanced goal planning, including making your investments more conservative as you near your goal.

Like a good human adviser, a robo-adviser tailors your investments to your needs. If you have a long-term goal such as retirement, the robo-adviser will tend to pick aggressive investments such as stock funds, which have a track record of high returns. If you have a short-term goal, the robo would likely select more conservative investments, such as bond funds or even cash.

To invest your portfolio, a robo-adviser typically uses exchange-traded funds (ETFs) that have certain characteristics, such as what they’re invested in (stocks, bonds, cash or some mixture), or a certain level of volatility, including very little volatility at all.

ETFs charge an expense ratio, which is a fee paid to the fund management firm based on how much you have in the fund. A typical expense ratio might be 0.05 percent to 0.35 percent per year, or $5 to $35 for every $10,000 invested. You pay these fees no matter which robo-adviser you select, but some robos offer funds with lower fees, so check what they’re charging.

With a robo-adviser, clients simply deposit money into the account, and the robo-adviser invests it according to the investment plan that’s been laid out. The client can access the robo-adviser account at any point of the day to see the current market value of the account and how it’s invested.

Biggest advantages of a robo-adviser

A robo-adviser really shines in a few key areas, especially where its automation gives it a real edge over human advisers. Robo-advisers can be very good at tedious or formulaic tasks, such as designing a portfolio based on your goals. (Human advisers excel at the more sophisticated and less-routine tasks – here’s how to decide which is better for you.)

Value-added features

As mentioned above, robo-advisers stand out in features that would simply be too tedious for a human to handle such as daily tax-loss harvesting. They also make rebalancing a portfolio easy, and they automate and simplify the process of investing a client’s money.

Simplicity

Investing with a robo-adviser is tremendously easy, because clients can simply send in money, and the robo does the rest. Investors don’t need to do anything else, and they can always check on the account or even adjust it, if needed, when their financial situation changes, for example.

Cost

Robo-advisers tend to be much cheaper than traditional financial advisers because everything is automated. Robos typically charge a percentage of the funds you have invested with them, and that fee is often around 0.25 percent per year, or about $25 per $10,000 you have invested. That’s a significant difference from the typical 1 percent charged by human advisers.

Some robos charge more, but offer higher levels of service, such as access to a human adviser. One even charges no fee at all, in part because it compensates by investing you in its funds.

Popular robo-advisers

Robo-advisers have grown a lot in the last decade, and many of the independent players – those that offer only robo-advisers – are the best known. However, other well-known financial players may also offer a robo-adviser as part of their total offering, so don’t assume the independent players such as Betterment, Wealthfront and Ellevest are the only game in town.

Betterment

Betterment is one of the larger independent players, and it requires no account minimum for the entry-level Digital account, which charges a management fee of 0.25 percent. If you’re looking for more access to certified financial planners, you can step up to Betterment Premium for a 0.4 percent fee, but you’ll need to plunk down at least $100,000 in the account.

Wealthfront

Wealthfront requires a $500 account minimum, but you’ll be able to have the first $5,000 in your account managed for free, skipping the robo’s usual 0.25 percent management fee. Wealthfront offers low expense ratios on its ETFs, no additional account fees and goal-based planning.

Ellevest

Ellevest is a newer player, and while it specifically markets itself to women (because traditional planning may not meet their needs), it’s suitable for anyone looking for client-first advice. It offers subscriptions at $1, $5 and $9 per month providing an array of services, rather than a fee based on your assets under management. Company founder Sallie Krawcheck has been a force in the financial world trying to provide women services that meet their specific situation.

Schwab Intelligent Portfolios

You might hear “Charles Schwab” and think “discount broker,” but this financial powerhouse also runs the second-largest robo-adviser. While you’ll need more money than other robos to get started – a hefty $5,000 – you won’t pay any management fee. You can also upgrade to the Premium offering, which requires a $25,000 deposit, $300 start-up fee and $30 monthly fee. But you’ll also have unlimited one-on-one access to a certified financial planner.

Vanguard Personal Advisor Services

And the top robo-adviser by assets under management is Vanguard, which is best known for its lineup of low-cost funds. But it also runs Personal Advisor Services and now Digital Advisor. It takes some coin to start investing with Personal Advisor – at least $50,000 – and you’ll pay a scaled fee based on your assets, starting at 0.3 percent and declining to 0.05 percent for accounts over $25 million. Meanwhile, the new Digital Advisor can also manage your investments at a lower upfront deposit of $3,000 and a $4.50 annual fee for each $3,000 you have invested.

Other larger financial players such as Merrill and Citibank have recently entered the robo-adviser field as well.

How to open a robo-adviser account

It’s surprisingly easy to open an account with a robo-adviser, and since they’re all web-based, you can get going at any time of the day or night. You’ll need some basic personal and financial information such as your Social Security number and bank account details, but you can usually open the account in 15 minutes or less.

Plus, you often don’t even need money to get started with many robo-advisers, though some may require that you deposit a nominal $5 to get going. However, others may require $100 or even $500 or more to start, but if that’s a concern, you have options to avoid an upfront deposit.

Once you’ve opened the account, the robo-adviser will use a questionnaire to gauge your risk tolerance and time horizon (i.e. when you need the money.) From there it will design a portfolio using ETFs that meets your parameters. The robo-adviser may ask other questions about your financial goals to further tailor your portfolio to your specific needs and situation.

Bottom line

While you might feel hesitant to trust your money to a computer app, robo-advisers are actually quite sophisticated. In fact, your traditional human adviser is likely using one anyway to create and manage your portfolio. Robo-advisers provide many attractive services for a reasonable cost, and their ease of use makes them particularly appealing to new investors looking to get started.

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