Robo-advisors are not advisors, but rather automated investment platforms that provide algorithm-generated portfolios to help individuals manage their money over time. As such, robo portfolios deliver a range of returns for investors, like any investment.
Robo-advisors are only automated in the sense that they use sophisticated technology to manage basic portfolios, typically composed of exchange-traded funds (ETFs) or other low-cost investments. Returns are not automated or guaranteed.
The underlying funds in a robo portfolio are the same or similar to those that regular investors can purchase on their own. Thus investors still need to consider the impact of gains and losses, taxes, and fees when thinking about robo-advisor returns.
Key Points
• Robo-advisors are automated portfolios, generated and managed by sophisticated algorithms.
• Investors supply some basic personal information and receive portfolio recommendations.
• The returns, positive or negative, from a robo-advisor platform are not automated or guaranteed, although the portfolios are designed to help manage risk.
• Automated portfolios are generally considered lower cost and consist of a basic assortment of exchange-traded funds.
• When choosing to invest in a robo-advisor portfolio, investors still need to consider the impact of taxes and fees over time, as these can impact returns.
How Robo-Advisors Help Investors
A robo-advisor is an automated, algorithm-based service that typically offers investors a questionnaire to assess their risk tolerance, time horizon, and investment goals. Based on these inputs, the robo-advisor platform suggests a portfolio that, ideally, will match the investor’s goals and preferences.
Robo-advisor algorithms typically employ some of the principles of modern portfolio theory (MPT), and other quantitative techniques, to establish and manage a range of pre-set portfolio options. Investors generally have a choice between more aggressive or more conservative investing allocations, but they typically cannot alter the makeup of an automated portfolio (unless that’s a feature specifically offered by a certain platform).
The algorithms used by robo-advisors are often updated to reflect changes in the market, and most rebalance on a regular cadence (e.g. annually) to maintain the portfolio’s asset allocation.
Robo Advisor Tools
Robo-advisors may also offer tools to help investors make decisions about their finances. These can include portfolio analysis tools, risk tolerance assessment tools, and educational resources. Investors can use these tools to monitor their portfolios and make informed decisions.
Robo-advisors typically charge a fee for their services, usually a percentage of the total portfolio value. However, the fees are generally lower than those traditional financial advisors charge.
The goal of robo-advisors is to provide a low-cost and convenient investing option to a wide range of customers, including those who may not have the resources or desire to work with a human, financial advisor — and those who prefer a more hands-off approach to their investments, whether they’re investing online or through a brokerage.
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Evaluating Robo-Advisor Performance
Evaluating the performance of a robo-advisor is critical for investors interested in using them to build wealth. Although some robo services claim to have proprietary algorithms based on investment theories developed by Nobel Prize-winning economists, these formulas simply inform the technology on the backend; they don’t guarantee a certain return or performance.
An investor should evaluate robo-advisor performance by considering its historic returns, cost, and other key metrics. By assessing the following metrics, investors can better understand the robo-advisor’s performance and how it aligns with their investment goals:
• Cost: The annual cost to invest with a certain robo advisor is one of the most important factors influencing returns that investors can control.
Robo advisors are generally lower cost than, say, working with a live financial advisor. But automated services charge annual fees, in addition to the expense ratios of the investments in the portfolio. Because fees eat into returns over time, it’s always important to know what the total costs are up front.
• Returns: It may be useful to compare the rate of return of a robo-advisor’s portfolios to relevant benchmarks. For instance, investors can look at the returns of their robo-advisor portfolio versus the S&P 500 Index. If the robo-advisor performs better than the S&P 500, it may indicate a well-run robo-advisor.
However, past performance is not predictive of future results, but it can provide a general idea of how the robo-advisor’s investments have performed over time.
• Diversification: Evaluate the diversification of the robo-advisor’s portfolios within and across different asset classes. Portfolio diversification can help manage risk by spreading investments across different types of securities.
• Rebalancing: Inquire how often and how the robo-advisor’s portfolios are rebalanced and how frequently the underlying investments are reviewed. Some robo-advisors offer automated tax-loss harvesting, which can be advantageous.
• Customer Service: Check if the robo-advisor provides access to a live advisor or customer support, as this can be an important factor if you need help or have questions.
What Is the Average Robo-Advisor Return?
The average return for a robo-advisor portfolio can vary depending on several factors, such as the portfolio’s specific investments (i.e., its allocation), the robo-advisor’s investment strategy, and overall market conditions.
In general, robo-advisors tend to invest in low-cost index funds and ETFs, which often track the broader market. Therefore, a robo-advisor portfolio’s returns may be similar to a mix of comparable index funds minus any advisory fees charged by the robo-advisor, plus the fees of the underlying funds.
Nonetheless, returns can vary widely depending on the robo-advisor and the portfolio. For example, as of November 30, 2024, the 3-year annualized trailing return for robo-advisors with portfolios with a 60/40 allocation ranged from 3.98% to 5.96%, net of fees.
Recommended: ETFs vs Index Funds: Differences and Similarities, Explained
Robo-Advisor Returns
Below are the returns of the top 10 largest robo-advisors by AUM, according to the Motley Fool. The returns shown in the table are from portfolios with a 60% stock and 40% bond asset allocation, net of fees, as of November 30, 2024.
| Robo-Advisor | Assets Under Management (AUM) | 5-Year trailing returns |
|---|---|---|
| Vanguard Digital Advisor | 333,066,527,268 | 4.01% |
| Betterment | $45,932,816,617 | 4.30% |
| Wealthfront Risk 4.0 | $35,915,923,641 | 5.96% |
| US Bancorp Automated Investor | $15,874,717,608 | 4.11% |
| Acorns | $8,210,969,354 | 5.38% |
| Stash | $3,343,843,237 | 5.51% |
| SigFig | $2,797,084,452 | 3.98% |
| Ellevest | $2,112,640,438 | 4.28% |
| Ally Invest | $1,127,619,162 | 4.17% |
| SoFi | $943,520,661 | 5.00% |
| Source: The Motley Fool, as of November 30, 2024. | ||
Understanding Robo-Advisor Fees
Understanding the different kinds of investment fees associated with robo-advisors, and how they compare to other investment options is critical for investors.
Investment fees are often expressed as a tiny percentage, e.g. 0.25% or 0.50%. But over time fees eat into a portfolio’s returns, making it harder for investors to build wealth. Analyzing robo-advisor expenses will help investors to determine if the robo-advisor is a cost-effective solution for their investment needs.
Note that all investment costs should be spelled out clearly for the investor (be sure to call customer service and ask, if they aren’t).
• Advisory Fees: This is the fee charged by the robo-advisor for managing the investor’s portfolio. It is typically a percentage of a portfolio’s assets under management and many robo-advisors charge less than 0.50%. Some robo-advisors offer fee-free options to their clients.
• Expense Ratios: An expense ratio is the fee charged by the underlying funds in the portfolio, such as ETFs. Expense ratios vary widely — a common range is 0.05% to 1.50%. Given the long-term impact of these fees, be sure to know what you’re paying up front.
• Account Minimums: Some robo-advisors may have minimum account balance requirements. A minimum account balance means investors must deposit a certain amount to open an account, which can be a headwind to opening an account if the investor starts with a small amount of capital.
• Other Fees: Some robo-advisors may charge additional fees for services such as tax-loss harvesting or closing an account.
Pros and Cons of Robo-Advisors
Robo-advisors are often appealing to many investors because of their hands-off nature. However, as with any financial product or service, there are pros and cons to using a robo-advisor.
|
Pros and Cons of Robo-Advisors |
|
|---|---|
| Pros | Cons |
| Relatively low cost vs. live advisors | Platforms charge a fee in addition to expense ratios |
| Convenient, and easy to use | Limited personalization |
| Provide basic diversification | Portfolio options are not flexible |
| Automatic rebalancing | Minimum balance requirements can limit access to certain features |
The pros of using robo-advisors include the following:
• Low cost: Robo-advisors typically have lower fees than traditional financial advisors, making them an attractive option for people who want to invest but avoid paying high fees. Some robo-advisors charge as little as 0.25% of assets under management, while traditional financial advisors may charge 1% or more. This can make a significant difference over time, especially for people with smaller portfolios.
• Convenience: Robo-advisors are available 24/7 and can be accessed from anywhere with an internet connection, which makes it easy for people to check their investments.
• Diversification: Robo-advisors use algorithms to create diversified portfolios with a mix of different index funds and ETFs in various asset classes, which can help investors reduce risk and improve returns.
The cons of using robo-advisors include the following:
• Limited personalization: Robo-advisors use algorithms to create portfolios, which may not take into account an individual’s unique financial situation or goals. A lack of personalization can be a problem for people with complex financial situations or who have specific investment goals that a robo-advisor may be unable to accommodate.
• Limited or no access to human advice: While some robo-advisors provide access to a financial advisor to help investors, these services can be limited or dependent on a minimum balance. As such they may not meet the needs of some users.
• Fewer investment options: Some robo-advisors may have limited investment options compared to traditional financial advisors or a self-directed brokerage account. For instance, robo-advisors tend to invest in ETFs rather than individual stocks. If an investor wants to put money into a specific stock or asset, they may want to open a self-directed brokerage account in addition to a robo-advisor portfolio.
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Can Investors Lose Money With Robo-Advisors?
As with any investment, investors can lose money with robo-advisors.
The underlying investments in an automated portfolio are generally ETFs that an investor can buy anywhere. In other words, these are ordinary investments that may gain or lose value.
That said, a robo portfolio is designed to provide a well-balanced allocation, based on the investor’s goal and time horizon, with the aim of mitigating the risk of losses. That said, there are no guarantees. And the term “automated” refers to the use of technology; it doesn’t mean returns are somehow automated.
Why Do People Use Robo-Advisors?
People use robo-advisors because they can be cheaper than traditional financial advisors, and because the investment choices are decided by an algorithm, some investors find it reassuring to know that there may be less risk of human error. Other investors may find that a robo-advisor offers greater convenience when managing investments.
Investors who are comfortable with the underlying technology that these services use may appreciate having certain investment chores automated for them.
For example, some robo-advisors will automatically rebalance the portfolio according to the investors’ risk tolerance, and investment goals. This ease of rebalancing can help investors maintain their desired risk level and ensure that their portfolio stays aligned with their investment goals.
Additionally, as noted above, some robo-advisors use automated tax-loss harvesting to help investors minimize their tax liability. Tax-loss harvesting is a technique that involves selling investments that have lost value to offset capital gains from other investments, which can help reduce the amount of taxes you owe. SoFi does not offer automated tax-loss harvesting.
The Takeaway
Robo-advisors use algorithms and technology to create and manage portfolios for investors. In recent years, robo-advisors have become increasingly popular as more and more people look for low-cost, convenient ways to invest their money. This has lowered the barrier to entry for many individuals, including younger people, to start investing.
Ready to start investing for your goals, but want some help? You might want to consider opening an automated investing account with SoFi. With SoFi Invest® automated investing, we provide a short questionnaire to learn about your goals and risk tolerance. Based on your replies, we then suggest a couple of portfolio options with a different mix of ETFs that might suit you.
FAQ
Do robo-advisors work?
Robo-advisors can be effective tools to help people invest their money and achieve their financial goals. Robo-advisors are generally cheaper and more convenient than traditional human financial advisors. However, it is important to research each robo-advisor to ensure it is the best fit for your needs, and that you’re comfortable with what a robo platform can and cannot do.
What are the differences between a robo-advisor and a financial advisor?
Robo-advisors typically have lower advisory fees and minimum deposit requirements, while financial advisors often require a minimum deposit and charge a percentage of the assets they manage. Another difference is that robo-advisors provide automated and algorithm-based guidance, while financial advisors provide personalized advice tailored to individual needs and goals.
Are robo-advisors good for retirees?
Robo-advisors can be a good option for some retirees because they can provide a low-cost, automated way to manage investments. However, if a retiree wants more personalized advice or help with tax and estate planning, a live advisor may be preferable.
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