• Skip to primary navigation
  • Skip to main content
  • Skip to primary sidebar
  • Skip to footer

The College Investor

Student Loans, Investing, Building Wealth

  • About
  • Podcast
  • Research
  • Contact
  • Save For College
      • How To Start

      • How To Save For College
      • How To Pay For College
      • What Is the Average Cost of College?
      • What Is A 529 Plan and Where to Open One in Your State
      • How Much Should You Have In A 529 Plan By Age
      • How To Use A 529 Plan For Private Elementary And High School
      • What Are Qualified Expenses For A 529 Plan (And What Doesn’t Count)?
      • The Best Brokers To Open A 529 Plan
      • Tools + Accounts

      • 529 Plans: The Ultimate College Savings Plan
      • 529 Plan Contribution Limits
      • Prepaid Tuition Plans | What To Know
      • Understanding And Using 529A ABLE Accounts
      • Using A Roth IRA To Save And Pay For College
      • FAFSA Deadlines for Financial Aid
      • CollegeBacker Review
      • Upromise Review
      • UNest Review
      • Other Options

      • Student Loan And Financial Aid Programs By State
      • The Guide To Military And VA Education Benefits
      • How To Fill Out The FAFSA
      • How To Find College Scholarships
      • The Best College Scholarship Search Websites
      • How To Find Grants To Pay For College
      • Pell Grants: What They Are And How To Qualify
      • Understanding Federal Work-Study
      • How To Use A 529 Plan If Your Child Doesn’t Go To College
  • Student Loans
      • Borrowing

        • How Student Loans Work
        • How To Apply For A Student Loan
        • How To Find The Best Student Loans And Rates
        • Best Private Student Loans Of May 2022
        • Best Student Loans To Pay For Graduate School
        • Best Student Loans To Pay For Medical School
        • Parent Loans To Pay For College
        • No-Cosigner Student Loan Options
        • Guide To Income Sharing Agreements (ISAs)
        • Best International Student Loans
      • Get Out Of Debt

        • Best Places To Refinance Student Loans In May 2022
        • Best Student Loan Repayment Plans
        • Best Student Loan Refinancing Bonuses And Promotional Offers
        • Student Loan Forgiveness Programs (The Complete List)
        • The Full List Of Student Loan Forgiveness Programs By State
        • Public Service Loan Forgiveness (PSLF)
        • Top Student Loan Scams
        • Average Student Loan Monthly Payment
        • Average Student Loan Debt By Year
      • Reviews

        • Credible Review
        • Splash Review
        • Ascent Review
        • Citizens Bank Review
        • Commonbond Review
        • Earnest Review
        • ELFI Review
        • Laurel Road Review
        • LendKey Review
        • SoFi Review
  • Investing
      • How To Start

        • How To Start Investing in High School
        • How To Start Investing In College
        • How To Start Investing In Your Twenties For 22 – 29 Year Olds
        • How To Start Investing In Your 30s For 30 – 39 Year Olds
        • How To Start Investing With $100 Or Less
        • How To Give Kids The Gift Of Stock
        • What Is Dividend Growth Investing
        • IRA Rollover Chart
      • Tools + Accounts

        • Best Online Stock Brokers
        • The Best Traditional And Roth IRA Accounts
        • The Best Robo-Advisors
        • The Best Investing Apps
        • The Best Places to Trade Options
        • The Best Places To Open A Health Savings Account
        • The Best Solo 401k Providers
        • The Best Self-Directed IRA Providers
        • Best Cryptocurrency Exchanges
      • Reviews

        • Vanguard Review
        • Fidelity Review 2022: Still One Of The Best Online Brokers
        • M1 Finance Review
        • TD Ameritrade Review
        • Charles Schwab Review
        • Robinhood Review
        • Webull Review
        • Betterment Review
        • Wealthfront Review
  • Earn More Money
      • Extra Income

        • 15 Best Side Hustles You Can Start Earning With Now
        • Side Hustle Ideas: 50+ Ways To Make Money Fast
        • 100+ Real And Honest Ways To Make Money In College
        • 80 Ways To Make Money From Home (In Your Pajamas)
        • 5 Quick Money Making Ideas (That Take Less Than 1 Hour)
        • 10 Interesting Ways You Can Make Money Driving
        • High-Paying Side Gigs That Earn $1,000 or More Per Month
        • The 10 Best Money-Making Apps
        • Paid Surveys: Earn Money For Giving Your Opinion Online
        • 10 Crazy Ways To Make $10,000 You’ve Never Heard Of
      • Build Wealth

        • 35 Passive Income Ideas You Can Use to Build Real Wealth
        • 3 Ways To Make $50,000 Per Year Without Working With Passive Income
        • How To Become A Real Estate Investor With Just $500
        • 15 Best Online Business Ideas
        • How to Create Streams of Passive Income on a Limited Budget
        • Residual Income: 7 Super Smart Ways to Build It
        • The Most Common Multiple Income Streams
        • How To Become A Real Estate Mogul With Only $10,000
      • Reviews

        • Fundrise Review
        • RealtyMogul Review
        • FarmTogether Review
        • AcreTrader Review
        • Swagbucks Review
        • Survey Junkie Review
        • TopCashback Review
        • DoorDash Review
  • Personal Finance
      • Banking

        • Best High Yield Savings Accounts Of May 2022
        • Best Money Market Accounts Of May 2022
        • 10 Best Free Checking Accounts In May 2022
        • The Best Bank CD Rates Of May 2022
        • 10 Best Business Checking Accounts In May 2022
        • The Best Online Banks Of May 2022
        • 5 Best Credit Unions Nationwide of May 2022
        • Best College Student Checking Accounts In May 2022
      • Insurance

        • Best Life Insurance Companies
        • Renters Insurance
        • Car Insurance
        • Pet Insurance
        • Umbrella Insurance
        • Disability Insurance
        • Tuition Insurance
        • Travel Insurance
      • Credit Tools

        • Best Budgeting Apps
        • Cash Advance Apps
        • How To Get A Free Credit Score Report
        • The Best Credit Monitoring Services
        • Debt Settlement: Inside The Secret World
        • Credit Repair Explained: Should You Pay For Help?
        • Best Personal Loan Companies And Lenders
        • Online Loan Companies To Borrow From Home
      • Tax

        • Best Tax Software
        • Free Tax Software
        • IRS Tax Refund Calendar
        • Common IRS Questions and Errors
        • Federal Tax Brackets
        • Capital Gains Tax Brackets
        • 401k Contribution Limits
        • IRA Contribution Limits
        • HSA Contribution Limits
  • Forum
  • Search
Home » Investing » Robo-Advisors » Robo-Advisors: What They Are And How They Work

Robo-Advisors: What They Are And How They Work

Updated: March 29, 2021 By Robert Farrington

Tweet
Share
Share
Pin
Email

At The College Investor, we want to help you navigate your finances. To do this, many or all of the products featured here may be from our partners. This doesn’t influence our evaluations or reviews. Our opinions are our own. Learn more here.Advertiser Disclosure

There are thousands of financial products and services out there, and we believe in helping you understand which is best for you, how it works, and will it actually help you achieve your financial goals. We're proud of our content and guidance, and the information we provide is objective, independent, and free.

But we do have to make money to pay our team and keep this website running! Our partners compensate us. TheCollegeInvestor.com has an advertising relationship with some or all of the offers included on this page, which may impact how, where, and in what order products and services may appear. The College Investor does not include all companies or offers available in the marketplace. And our partners can never pay us to guarantee favorable reviews (or even pay for a review of their product to begin with).

For more information and a complete list of our advertising partners, please check out our full Advertising Disclosure. TheCollegeInvestor.com strives to keep its information accurate and up to date. The information in our reviews could be different from what you find when visiting a financial institution, service provider or a specific product's website. All products and services are presented without warranty.

robo-advisors

Automation has affected large swaths of the modern economy. And everyday investors can benefit from automation too. Robo-advisors are platforms that use algorithms to automate investments on behalf of clients. 

These platforms make it easy for investors to “do the right things” automatically. And because the advice and actions that a robo-advisor takes on behalf of its clients is automated by computers, their fees are usually much lower than you'd pay to a human financial advisor.

Robo-advisors occupy a sort of middle-ground between 100% DIY and fully managed investing. But are they right for you? In this article, we explain how robo-advisors work, when they may make sense, and when to avoid them.

Table of Contents
What Is A Robo-Advisor?
How Do Robo-Advisors Work?
How Much Do Robo-Advisors Cost?
Do DIY Investors Need A Robo-Advisor?
Times To Consider A Robo-Advisor
Times To Avoid A Robo-Advisor
Final Thoughts

What Is A Robo-Advisor?

A robo-advisor is a common name for a platform that helps users invest into financial markets using some sort of algorithm. Although they have the word “advisor” in the name, most don’t offer human financial planning advice unless clients pay extra for it.

The overwhelming majority of robo-advisors follow a time-tested strategy called Modern Portfolio Theory. This strategy involves investing in low-cost, broad-based index funds (usually ETFs), with a representation of Domestic, International, Growth, Income, and Small Cap stocks. 

However, some invest in individual stocks, active mutual funds, or follow strategies outside of traditional index fund investing. Wealthfront and Betterment are some of best-known names in robo-advising, but there are many more worth considering (especially little known names like M1 Finance).

Most robo-advisors offer some degree of customization (based on your age, risk tolerance, timeline to your goal, etc.), but will do all the investing on your behalf. When it comes to investing, you can put money into a robo-advisor platform and know that it is being invested with a goal towards sustainable growth and tax efficiency.

How Do Robo-Advisors Work?

The common thread among all robo-advisors is that the platforms operate programmatically. Computers invest your money using some predictable strategy. No human intervenes in the investing (unless you pull money out or put money in).

Most robo-advisors invest your money into ETFs or mutual funds. Whenever you deposit money to the platform, the platform will buy partial shares of your investments. Periodically, the robo-advisor will sell some of your best performing assets, to buy some of the lowest performing assets. This is called “rebalancing," and it is one of the top benefits of robo-advisors.

Robo-advisors also record all the trades that they do on investors behalf. This allows the investors to accurately account for gains and losses at tax time. It also allows investors to take advantage of tax-loss harvesting rules to lower their tax burden by offsetting their gains with their losses.

How Much Do Robo-Advisors Cost?

As robo-advisors become more common, the average price of using them is falling. In general, they use an Assets Under Management (AUM) model of pricing. That means the price you’ll pay is a percentage of your total money invested on the platform.

Prices tend to range from 0.25% to 0.75% of Assets Under Management per year. If you have $100,000 under management and your fee is 0.25%, you’ll pay $250 per year for the robo-advisor's services.

In addition to the management fee, you’ll have to pay fees on the underlying investments in the portfolio. The most popular providers use extremely low-cost ETFs or stocks to keep “internal costs” low for investors. However, the cost of investments is worth investigating if you’re considering a robo-advisor.

Do DIY Investors Need A Robo-Advisor?

Robo-advisors provide a useful service to a segment of investors. People who have the desire to invest but don’t want to worry about technical matters like learning how to buy funds or manage a portfolio may benefit from using one.

However, the benefits of tax efficiency are only important to borrowers with after-tax brokerage accounts. But, in general, the only investors who should consider opening a taxable account are those who have maxed out their retirement account options. And that's a fairly thin slice of the population.

Additionally, the benefits of a well-diversified portfolio can be achieved with two to five broad-based index funds. The basics of investing can be easy to learn. But if you don’t care to learn them, then a robo-advisor or human financial advisor is a must. 

Times To Consider A Robo-Advisor

While robo-advisors aren’t for everyone, some investors may benefit from using one. These are the times to consider using a robo-advisor to invest.

You Don’t Care To Learn The Technical Aspects Of Investing

Learning to invest in financial markets isn't tough. But you will need to figure out where to open an account, what type of account to open, how to buy investments, and how to keep buying into the market. Over time, you will need to learn about things like Asset Allocation and portfolio management.

Many successful investors use simple strategies (similar to those employed by the Robo-Advisors) on their own. But if you’re someone who doesn’t want to learn about investing, you can offload the technical aspects of investing onto a robo-advisor.

You’re Seeking Tax Efficiency

If you’ve got a lot of money in a savings account, or in an after-tax brokerage account, using a robo-advisor could be a smart move for you.

Robo-advisors take advantage of tax-loss harvesting, which allows investors to sell investments for nominal losses, and thereby show losses in their portfolio. This allows the investor to offset the taxes they have to pay on gains.

Tax loss harvesting is technically challenging but very profitable for people with large amounts of money in non-retirement accounts. For this type of investor, using a robo-advisor can pay off.

You Want To Get Started With Limited Fuss

Robo-advisors can be a great way to dip your toes into the financial markets. The platforms are easy to use and they help beginner investors avoid some of big mistakes (such as trading too often, or being under-diversified).

If you have money you want to invest today, a robo-advisor can help you get started. They can help you move past analysis paralysis and get you moving in the right direction.

Times To Avoid A Robo-Advisor

Here are a few situations where using a robo-advisor may not be your best option.

You Want Somone To Motivate You To Stick With Your Plan

Robo-advisors aren’t humans. They aren’t going to “talk you off the ledge” when you want to sell low and buy high. They can't help you master some of the more difficult aspects of behavioral finance. Financial counselors and Certified Financial Planners (CFPs) are better equipped to help humans handle the emotional ups and downs of investing.

You Have A High Risk Tolerance

Most robo-advisors automatically invest some portion of investors money into bonds, cash or similar low volatility options. Most strategically invest a larger share of the money into those “safe havens” as investors get closer to their goal date (including retirement).

If you have a high risk tolerance, or you need higher returns to meet your goal, safe haven investing may not make sense for you. Be sure to investigate whether the standard allocation (and the change in allocation over time), makes sense given your appetite for risk.

You Want To Actively Invest Or Select Individual Stocks

Robo-Advisors are passive investment platforms. Those who want to invest in individual stocks or actively manage their portfolios according to certain rules aren’t good candidates for this type of investing. Robo-advisors help users stick to a prescribed path and that path doesn’t involve selecting individual stocks.

You’re Willing To Learn The Technical Aspects Of Investing

As previously mentioned, most people can easily learn the basics of investing by reading a single book, taking a short course, or by reading a few articles every day.

Learning the technical basics of investing can keep you from being hoodwinked by nefarious actors and can keep you from freaking out when you see losses in your portfolio. If you’re willing to that, and you have the time, you can probably skip the robo-advisors.

Your Only Accounts Are Employer-Sponsored Accounts

A lot of people start investing through employer-sponsored retirement accounts like 401k accounts or 403b accounts. If you have one of these accounts, you’re stuck with your employer’s chosen provider and don’t need to worry about robo-advisors unless you choose to leave your company (and want to rollover the account).

Most Popular Robo-Advisors

Now that you understand the basics of robo-advisors, here are the most popular ones:

Betterment Sqaure Logo

Betterment

Betterment is one of the largest robo-advisors out there, and it's become more popular with additional offerings such as banking and access to CFPs. They currently charge 0.15% AUM to start, which is one of the lowest fees you'll find in the space. If you're considering a robo-advisor, this should be a top contender for you. Check out Betterment here >>

Wealthfront Square Logo

Wealthfront

Wealthfront is incredibly similar to Betterment, and as such, also has a lot of popularity. They help with financial planning via their software, and they have also created banking products to rival Betterment. They do charge slightly more, at 0.25% AUM. Check out Wealthfront here >>


Final Thoughts

For a modest cost, a robo-advisor can push you towards a tax-efficient, well-diversified portfolio of stocks, bonds and other financial instruments. Of course, with some work, you can also build that with DIY investing. But you need to be honest with yourself about whether you’ll actually do that.

I like robo-advisors for people that have struggled to get started with investing. The platforms make it easy to automate great behavior such as investing regularly, rebalancing, and sticking with your asset allocation.

But if you'd like to be more hands-on with your investing decisions, a discount stock broker will be a better choice. These are our favorite stock brokers for 2020.

Robert Farrington
Robert Farrington

Robert Farrington is America’s Millennial Money Expert® and America’s Student Loan Debt Expert™, and the founder of The College Investor, a personal finance site dedicated to helping millennials escape student loan debt to start investing and building wealth for the future. You can learn more about him on the About Page, or on his personal site RobertFarrington.com.

He regularly writes about investing, student loan debt, and general personal finance topics geared towards anyone wanting to earn more, get out of debt, and start building wealth for the future.

He has been quoted in major publications including the New York Times, Washington Post, Fox, ABC, NBC, and more. He is also a regular contributor to Forbes.

Robo-Advisors: What They Are And How They Work
Editorial Disclaimer: Opinions expressed here are author’s alone, not those of any bank, credit card issuer, airlines or hotel chain, or other advertiser and have not been reviewed, approved or otherwise endorsed by any of these entities.
Comment Policy: We invite readers to respond with questions or comments. Comments may be held for moderation and are subject to approval. Comments are solely the opinions of their authors'. The responses in the comments below are not provided or commissioned by any advertiser. Responses have not been reviewed, approved or otherwise endorsed by any company. It is not anyone's responsibility to ensure all posts and/or questions are answered.
Subscribe
Connect with
I allow to create an account
When you login first time using a Social Login button, we collect your account public profile information shared by Social Login provider, based on your privacy settings. We also get your email address to automatically create an account for you in our website. Once your account is created, you'll be logged-in to this account.
DisagreeAgree
Notify of
I allow to create an account
When you login first time using a Social Login button, we collect your account public profile information shared by Social Login provider, based on your privacy settings. We also get your email address to automatically create an account for you in our website. Once your account is created, you'll be logged-in to this account.
DisagreeAgree
0 Comments
Inline Feedbacks
View all comments

Primary Sidebar

Robert Farrington

Hi! My Name is

America's Millennial Money Expert

Welcome to The College Investor. We're here to help you escape student loan debt so you can start investing and building wealth for the future

Our expert guides, reviews, and more are designed to help you achieve your financial goals.

Want to learn more? See what's in my wallet.

As Featured In

Social Media

Popular Posts

Side Hustling

Side Hustle Ideas: 50+ Ways To Make Money Fast

Best Side Hustles

15 Best Side Hustles You Can Start Earning With Now

Make Money From Home

80 Ways To Make Money From Home (In Your Pajamas)

Crazy Ways To Make $10,000

10 Crazy Ways To Make $10,000 You’ve Never Heard Of

Make $50,000 Per Year

3 Ways To Make $50,000 Per Year Without Working With Passive Income

Student Loan Scams

Top Student Loan Scams

Net Worth of Millennials

The Average Net Worth Of Millennials By Age

Ways To Get Student Loan Forgiveness

Student Loan Forgiveness Programs (The Complete List)

Passive Income Ideas

35 Passive Income Ideas You Can Use to Build Real Wealth

529 Plan By Age

How Much Should You Have In A 529 Plan By Age

Ultimate Guides

529 Plan Guide

529 Plans: The Ultimate Guide To College Savings Plans

Student Loans and Financial Aid By State

Student Loan And Financial Aid Programs By State

Student Loan Advice

The Definitive Guide To Student Loan Debt: Everything To Know About Your Loans

Student Loan Forgiveness By State

The Full List Of Student Loan Forgiveness Programs By State

newretirement

How to Start Saving Now: The College Graduate’s Guide to Saving for Retirement

Latest Research

Institutional Merit Grants

Who Gets Institutional Merit Grants At Private Colleges?

Resume Student Loan Payments

Survey: Even With Higher Expenses, Most Student Loan Borrowers Are Ready To Resume Payments

Support From Parents Survey

64% Of Millennials Receive Support From Their Parents

undermatching at selective colleges

Undermatching: Why Do Smart Low-Income Students Not Enroll In Selective Colleges?

How Much Americans Pay To File Their Taxes

How Much Americans Pay To File Their Taxes

Footer

Banking

  • 10 Best Free Checking Accounts In May 2022
  • The Best Online Banks Of May 2022
  • The Best Bank CD Rates Of May 2022
  • Best Money Market Accounts Of May 2022
  • Best High Yield Savings Accounts Of May 2022
  • Best High-Yield Checking Accounts Of May 2022
  • The Best Bank Bonus Offers
  • The Best Business Checking Accounts

Investing

  • Best Online Stock Brokers In 2022 (According To Readers)
  • Best Brokerage and Investing Bonus Offers In May 2022
  • The Best Places To Open An HSA (Health Savings Account)
  • 5 Best Investing Apps With Free Stock Trading
  • How To Buy Stocks Online For Free
  • The Best Robo-Advisors Of 2022
  • The Best Self-Directed IRA Providers
  • The Best Traditional And Roth IRA Accounts Of 2022
  • Comparing The Most Popular Solo 401k Options
  • Top 3 Automatic Investment Apps Of 2022

Student Loans

  • Best Places To Refinance Student Loans In May 2022
  • Best Private Student Loans Of May 2022
  • How To Find The Best Student Loans And Rates
  • Best Student Loan Refinancing Bonuses And Promotional Offers

Insurance

  • The Top 10 Online Life Insurance Companies
  • The Ultimate Guide To Renters Insurance – Everything You Need To Know
  • The Cheapest Car Insurance For College Students

Connect

  • Contact Us
  • Advertise
  • Press & Media

About

  • About
  • Our Team
  • Podcast
  • Editorial Guidelines
  • How We Make Money
  • Archives

Social

Copyright © 2022 · The College Investor · Privacy Policy ·Terms of Service · DO NOT Sell My Personal Information

wpDiscuz