November 24, 2021

What is a robo-advisor and how does it work?

Robo-advisors are financial advisors that automate the process of financial planning and investing.

What is Robo-advising?

Robo-advisor provides automated financial planning and investing and is typically used in place of a traditional financial planner. Robo-investing is often an easier, more convenient way to invest than working with a human financial advisor.

What is the Robo-investment process?

A robo-advisor’s job is to create and manage customized investment portfolios. Users sign a discretionary management agreement with the robo-advisor, allowing the service to invest funds, allocating initial capital and making future adjustments to investments and strategies based on market conditions. 

Here are the three basic steps in Robo-investing.

1. Create an account and deposit funds

Once you’ve selected a robo-advisor, you’ll open an account with the service. You’ll be asked a series of questions, like your age, investment goals and risk tolerance, that will help determine investment options suitable for you. 

You’ll also need to establish a bank account to fund the account. While it's important to make an initial deposit, most robo-advisors require a bank account remain linked and connected to enable fund transfers. 

2. Robo-advisor allocates funds

Your answers to the questionnaire help the robo-advisor determine how to invest your money and the asset classes in which to allocate your funds. Most robo-advisors use a strategy known as a modern portfolio theory, which prioritizes diversification to avoid risk, investing in low-cost mutual funds or exchange traded funds across different assets while also offering tax-loss harvesting.

Your goals are important, and the robo-advisor will use them to help determine the appropriate asset allocation - the right balance of high- and low-risk investments that help ensure your investment will grow to meet your goals. 

3. Robo-advisor manages your account

Over the short- and long-term, robo-advisors automatically adjust to market conditions, a process known as "rebalancing,” to ensure your money grows to meet your goals. Most robo-advisors are required to report their progress to you, and many provide options for optimizing your investments’ performance.

What are the downsides of Robo-advisors?

  • Robo-advisors aren’t for everyone, especially if you’re distrustful of technology.  Second-guessing their decisions and disrupting the normal course of investing can throw off your portfolio’s performance, undermining their value.
  • Many robo-advisors are priced competitively, but not all. Avoid services that charge a 1% annual fee on assets under management. 
  • Robo-advisors don't have an office or a human financial advisor. So they may not meet the needs of users accustomed to getting advice from a traditional advisor.
  • Robo-advisors are very general in their offerings. For example, some aren’t designed to trade specific stocks; you’ll need a more specialized service or a separate brokerage account for specific transactions.

How to select a Robo-advisor

Different robo-investors offer different kinds of investments. Some are focused on retirement investing, others are designed for a variety of goals, with a variety of investing options. When selecting a service, ask yourself these two questions.

What types of investing are offered?

Most robo-advisors offer ETFs or index funds or both. Typically, you can choose between a few funds, comparing risks, performance, fees and strategies. With some robo-advisors, you can define your goals and let the service make all the decisions for you. 

Some enable more specific transactions, like fractional shares and individual stock trading. Regardless of your initial choice, it’s important to monitor your robo-advisor’s progress. Pay attention to the fees, and make sure your robo-advisor of choice is designed to meet your individual goals. 

What are your investing goals?

If you have short- or intermediate-term goals, like homebuying or a wedding or other milestones expenses short of retirement, a standard investment account offers the flexibility you may need. They often don’t have limits on how much money you can invest or withdraw. 

In contrast, many retirement accounts and education-specific accounts have contribution restrictions. They limit how much you can add to them each year and typically have restrictions on how much you can withdraw. With tax-deferred benefits, they’re designed for long-term goals.

When choosing a robo-advisor, make sure it offers accounts and investing options that match your goals. Some robo-advisors require a large initial deposit to get started, too, and some charge penalties if your balance falls below their account minimums.

Which Robo-advisors have the best returns? 

Here’s a short list of robo-advisors with competitive returns.

  • Betterment. Betterment requires no minimum balance. The basic service has an annual fee of 0.25% and also offers automatic tax loss harvesting as well as features a variety of tax-efficient options designed to help minimize your tax bill. The premium service requires an account minimum of $100,000 and offers more sophisticated services. 
  • SoFi Automated Investing. SoFi requires a minimum of $5 to open an account. In addition to mutual fund and ETF investing, SoFi also enables no-fee stock trading, fractional shares and other specific transactions.
  • Wealthfront: Wealthfront requires $500 to open an account and offers a variety of diversified funds, along with tools to manage your risk tolerance and financial goals.
  • Schwab Intelligent Portfolios: Schwab’s robo-advisor requires $5,000 minimum balance. Users pay expense ratios that vary depending on the size of their investments.
  • Ally Invest: Ally requires a minimum of $100 to start investing, includes an expense ratio of 0.07% and requires investors to hold at least 30% of their portfolio as interest-earning cash.

                                       Financial Planning with Bright to stay on track with your finances.

Is Bright an auto-advisor?

Bright does not offer investing as a robo-advisor, but we do use MoneyScience™, a new patented system of 34 algorithms to delete debt and build wealth. Bright’s MoneyScience™ studies your finances, learns about your goals, then makes smart credit card payments for you, while also building your savings, automatically.

Bright pays off cards 8x faster than most users can on their own, and we save the average user $744 in fees and charges each year. Bright also builds a personalized financial plan for every user, a step-by-step path for reaching your goals. 

If you don't have it already, download the Bright app from the App Store or Google Play. Link your checking account and your cards, set a few goals and let Bright get to work.

Recommended Readings:

What is the best robo advisor?

How to Choose The Right Investment for You

Pranay Chirla
Technical Content Writer
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