What is a robo-advisor?

Robo-advisors are automated investment platforms that provide algorithm-based financial planning and portfolio management services with almost no human supervision. They use algorithms and mathematical models, developed by human investors, to manage investment portfolios automatically.

A robo-advisor will assess your risk tolerance, determine your investment time horizon and goals, and build your investment portfolio to maximize return potential without too much risk. They’re cheaper, simpler, and more accessible to everyday investors than investing with a human advisor.

The downside of a robo-advisor is that you don’t have full control over what stocks you actually own. Robo-advisors are invest based on modern portfolio theory, which diversifies your portfolio to match the market. If you want to try and beat the market by picking individual stocks, a robo-advisor may not be the best fit for you.

​​How does a robo-advisor work?

Similar to a human wealth manager or investment advisor, a robo-advisor will start by asking you a few questions about your current situation, financial goals, and risk appetite.

  • How much money do you make?
  • How much do you have in savings?
  • How much are you willing to invest?
  • What are you saving for?
  • What’s your risk tolerance?

Using your answers, the robo-advisor will then build you an investment portfolio mathematically engineered to meet your goals. As the market changes, it continually updates your portfolio.

What does a robo-advisor invest in?

Robo-advisors mainly invest your funds in a diverse portfolio of mutual funds and ETFs, like the S&P 500 or the US bond market using a passive investment approach. The specific funds and ETFs they’ll invest in depends on your risk profile and goals. 

Portfolio rebalancing

Rebalancing is the buying and selling of assets to maintain a certain level of allocation or risk.

For example, let’s say that based on your risk profile and goals, your robo-advisor builds you a portfolio that consists of:

  • 25% in growth stocks.
  • 25% in blue chip stocks.
  • 50% in government bonds.

If your growth stocks rally, the balance gets thrown off since your portfolio will now consist of a higher percentage of assets in growth stocks. Your robo-advisor will then sell some of your growth stocks and invest in other categories to maintain your ratio.

Tax-loss harvesting

The primary goal of tax-loss harvesting is to reduce the investor’s tax liability by strategically realizing losses to offset gains. By doing so, investors can lower their overall taxable income and potentially reduce their tax bill.

When you sell stocks at a profit, you’ll have to pay capital gains taxes. This is where tax-loss harvesting comes in. By strategically selling some losing stocks at a loss, your robo-advisor can offset the gains and minimize your tax bill. They do this by holding at least two or more ETFs for each asset class. 

For example, if your holdings in the S&P 500 dips in value, a robo-advisor will automatically sell it at a loss and buy a different S&P 500 ETF. That way, you could still capture the tax benefits of the loss but maintain your desired investment exposure in the asset. If the investment goes back up, you’d still reap the rewards with your new investment. 

Rebalancing and tax-loss harvesting are time-consuming and tedious work. Many human advisors will only do them for you once or twice a year, and individual investors may find it too complicating to do it themselves. However, a robo-advisor can do it everyday and find opportunities that human eyes may have difficulty spotting.

How much does a robo-advisor cost?

Because everything is automated, robo-advisors have lower fees than traditional human advisors and have lower (or zero) minimum balance requirements to get started.  Most human advisors charge an AUM fee of around 1% to 2%. Many will also require a minimum investment, with many requiring at least $100,000 in your balance. Robo-advisors typically charge 0.2% to 0.5% annual fees with no minimum requirements.

Robo-advisor fees of popular platforms:

  • Betterment: 0.25% to 0.4% of your account balance.
  • Wealthfront: 0.25% of your account balance.
  • Personal Capital: 0.49% to 0.89% of your account balance.
  • Acorns: $3 to $5 per month.

The new Carry Robo-advisor comes with zero fees. Open an account and get started in under 10 minutes → 

Advantages of using a robo-advisor

Easy to get started

Robo-advisors provide an accessible entry point to investing. They have low or no minimum investment requirements, making them suitable if you have limited capital or if you’re just getting started on your investment journey. They also usually come with user-friendly interfaces built with the beginner in mind, making it easy to open accounts, set your investing goals, and monitor your portfolios. Many robo-advisors also come with a library of training and educational resources to help you make more informed decisions.

Available 24/7

With a human advisor, your contact is limited to their hours of operation. To execute a trade, you’d normally have to call or meet them and wait for them to execute your desired trades. 

A robo-advisor is available 24/7, operated entirely online, and you can deposit, make withdrawals, check your balance, and make adjustments completely at any time, from the comfort of your own home.

Lower fees

As mentioned earlier, robo-advisors are considerably cheaper than a traditional human advisor or wealth manager. Through automation, robo-advisors can build and manage your portfolio at a fraction of the cost of human advisors.

Lower capital required

Robo-advisors require a lower account balance to get started than if you were to invest with a human advisor. A human advisor may have a required minimum balance ranging between $25,000 to $1 million depending on the advisor. A robo-advisor typically only require between $1 to $3,000, with many having $0 account minimums.

Makes it easy to build a diverse portfolio

Robo-advisors emphasize portfolio diversification. They allocate investments across different asset classes and often use low-cost index funds or ETFs. This diversification helps reduce risk by spreading investments across multiple securities, sectors, and geographic regions.

Removes the risk of investing emotionally

Robo-advisors remove emotional biases from your investment decisions and follow disciplined investment strategies based around predetermined algorithms and investment models. This eliminates the risk of you making impulsive decisions during volatile market conditions.

Automated rebalancing and tax-loss harvesting

As we went through above, the best robo-advisor platforms will automatically rebalance your portfolio periodically to ensure it stays aligned with your risk tolerance and investment goals. This eliminates the need for manual portfolio rebalancing, saving time and effort. A robo-advisor will also automatically reduce your tax obligations through tax-loss harvesting, which can be time-consuming and complicating for individual investors to do on their own.

Ability to invest through a variety of accounts

Most robo-advisors let you choose what account you want to invest from. You can use a robo-advisor to invest through individual investing accounts, savings accounts, and even retirement accounts.

When you sign up with a robo-advisor, you’ll usually have the option to choose which type of accounts you want to open and invest through.

With Carry, you can use our no-fee robo-advisor with a traditional or Roth IRA and our Solo 401k.

Disadvantages of using a robo-advisor

Lack of human interaction

Human advisors can offer personalized financial advice and tailored investment strategies based on individual circumstances, goals, and risk profiles. They can take into account non-financial factors and provide emotional support and guidance during unstable market conditions or major life events. A robo-advisor is unable to offer reassurance, perspective, and guidance that goes beyond the scope of automated algorithms.

With the Carry, you get the best of both worlds with zero AUM fees.

As a Professional Plan member, you get 24/7 access to your very own financial planner, who will start by assessing your financial situation and goals and building you a custom financial plan. Consult them about investing through Carry’s robo-advisor, what your risk preferences should be, and what accounts you should be prioritizing. Whenever you need help or if you’re unsure about anything, you can contact them and ask them questions at any time.

Inability to handle complex situations

Robo-advisors are generally designed for straightforward investment needs. They may struggle to address complex financial situations that require specialized knowledge. Human advisors are better equipped to handle complex financial situations, such as tax planning, estate planning, and retirement strategies. They can adapt investment strategies based on changing market conditions and evolving client needs.

Robo-advisors use algorithms to provide investment advice, which means they may not consider individual circumstances, goals, and preferences as comprehensively as human advisors. They rely on standardized questionnaires to assess risk tolerance and investment goals, which may not capture all the nuances of your specific financial situation. On the other hand, human advisors can exercise judgment and intuition based on their experience and expertise. They can analyze qualitative factors, consider market trends, and potentially identify investment opportunities that automated systems might overlook.

Algorithm Limitations

The performance and accuracy of robo-advisor algorithms depend on the quality and reliability of the underlying data and assumptions. While these algorithms are constantly improving, they may still be subject to errors or biases that could impact investment decisions. Additionally, robo-advisors heavily rely on technology. While this allows for convenience and accessibility, it also introduces the risk of technical glitches, system failures, or cyber threats that could potentially disrupt the investment management process.

Limited investment options

Robo-advisors only offer a selection of pre-built portfolios or use passive investment strategies such as index funds or ETFs. This limited range of investment options may not cater to investors seeking more specialized or alternative investment opportunities.

Who should use a robo-advisor?

A robo-advisor can be a good option for beginners investing for the first time, and investors who want a lower-fee, more passive approach to investing in the market.

  • New investors: If you’re not comfortable making your own investment decisions, a robo-advisor can help you build an optimal portfolio with lower risk based on your financial goals.
  • Hands-off investors: If you’re an experienced investor, but don’t want to spend time researching and managing your own investments, a robo-advisor can put your investing on autopilot.
  • Reduce taxes: Tax-loss harvesting is complicating and time-consuming for the average investor to do on their own. Rather than spending money to work with a human advisor, you can use a robo-advisor to have it done automatically.
  • Lower fees: A robo-advisor costs a fraction of what human advisors charge. If you’re worried about paying too much in fees for a wealth manager or human advisor, and don’t require more complex tax planning, estate planning, and retirement strategies, a robo-advisor could be a more cost-efficient option.