Are robo-advisors worth it?

Robo-advisors have made investing easy.

Simply download the app. Answer some questions. Deposit your money.

And voila! You’re now saving for retirement!

But are robo-advisors worth it? Or are they just subpar replacements for actual financial advisors?

In this article, we’ll break down how robo-advisors work, how much they cost, and show you actual returns compared to financial advisors. And we’ll show you exactly who robo-advisors are for (and who should avoid them).

A robo-advisor is an automated investment service that helps you build an investment portfolio and manages your investments for you. Similar to a financial advisor, rob-advisors consider your age, income, risk tolerance, and other factors to build a diversified portfolio of ETFs that help you hit your financial goals.

But robo-advisors charge far less in fees than traditional financial advisors — around 0.25% of your investment balance vs. the 1% fee charged by most advisors. Robo-advisors also automatically rebalance your portfolio periodically, and can even help you with optimizing your taxes.

Overall, robo-advisors are an easy way to automate your investing while avoiding the high fees of professional money managers.

Robo-advisors use advanced algorithms to help you build a diversified investment portfolio based on your goals and risk tolerance. To start investing with a robo-advisor, you will need to sign up for an account, either online or through a mobile app.

Most robo-advisors have an onboarding questionnaire to help gauge your risk tolerance, asking you questions about how you view your investments, and how comfortable you are with a drop in the value of your portfolio.

After completing the onboarding process, you are presented with a pre-built portfolio of ETFs. These ETFs are typically spread across stocks and bonds, representing multiple market sectors and asset classes. Most robo-advisors will let you customize the portfolio slightly, but you can’t typically choose individual stocks or funds.

Once you commit to a portfolio, you can link your bank account and deposit funds. The deposited money will get split between the pre-selected investments for you, and you can track your portfolio through the accompanying mobile app.

Some robo-advisor services offer more advanced money management, including features like tax-loss harvesting, portfolio margin loans, goal-tracking apps, and automated money transfers. A robo-advisor might even offer access to licensed financial advisors who can answer your money questions and help ensure your investments are set up properly within the app.

Robo-advisors typically utilize a portfolio of low-fee ETFs to help keep your investment costs low, and to build in diversification by holding funds that own hundreds of underlying investments.

These funds can include multiple market sectors and asset classes, like stocks, bonds, real estate, commodities, and other investments. The return on investment will vary by portfolio, and not everyone will have the same investment mix.

Most robo-advisors don’t have a long track record. But according to the Robo Report, the five-year returns (2017 to 2022) from most robo-advisors range from 2% to 5% per year. And Wealthfront, one of the best robo-advisors available, also states that customers can expect about a 4% to 6% return per year, depending on their risk tolerance.

Compare these returns to, say, Vanguard’s S&P 500 index fund (VOO) with a return of about 10.94% per year (five-year average, based on data collected on 11-30-22), and it would seem these robo-advisors are underperforming.

But remember, not everyone wants to risk their entire portfolio on stocks, and a balanced portfolio hasn’t returned 13% per year. In fact, the traditional 60% stocks / 40% bonds portfolio has returned about 6.4% over the past five years.

A note about short-term returns

One thing to keep in mind is that annual average returns can vary dramatically depending on your start date and end date.

The S&P 500, for instance, has an (inflation-adjusted) average annual return of 6.5% since its inception in 1928. But when an investor entered the market would seriously affect their returns.

Those who entered in the late 60s, for instance, wouldn’t have much of a return for years. One who put his money in in the 50s, however, would be doing great. Like so many things, timing can have an impact.

This holds true for more recent years, as well.

The later you came into the rally, the less it did for you. (This is why it’s so important not to panic sell after a market drop; you miss out on the inevitable rally.)

So yes, it would appear on the surface that robo-advisors are underperforming currently, but when compared to a balanced portfolio, it seems they are not too far off.

While robo-advisors offer solid investment advice and the ability to automate your investments, they aren’t free. And the fees that you pay for these services can eat into your total returns.

But the good news is that robo-advisors are much cheaper than their counterparts. While most investment advisors charge about 1% of assets under management (AUM), robo-advisors typically charge about 0.25% AUM (or less). There are some robo-advisors that charge a flat monthly fee, but these services are typically not a great deal for investors with small amounts invested.

In addition to the management fee, investors will pay the expense ratio of any of the funds they are placed in as part of the investment portfolio. Luckily, most robo-advisors stick to low-cost ETFs that charge less than 0.10% per year.

Robo-advisor vs. index fund

You might be able to build your own portfolio by picking out a good mix of index funds yourself. This is a cheaper route compared to robo-advisors (as far as fees go), but possibly riskier as well, as you need to understand what you are investing in at a deeper level. But the returns may be more robust, netting you more growth.

Here’s how your portfolio would compare when held in a robo-advisor vs. simply investing in index funds:

Robo-advisor ($500/mo invested, 6% return, 0.25% fee):

• 5-year index fund portfolio value = $35,589.26 ($35,851.91 – $262.65 in fees)
• 10-year index fund portfolio value = $82,656.72 ($83,829.86 – $1,173.14 in fees)
• 20-year index fund portfolio value = $227,227.97 ($233,956.36 – $6,728.39 in fees)
• 30-year index fund portfolio value = $480,091.21 ($502,810.06 – $22,718.85 in fees)
• 40-year index-fund portfolio value = $922,363.22 ($984,286.10 – $61,922.88 in fees)

Index funds ($500/mo invested, 8% return, 0.04% fee):

• 5-year index fund portfolio value = $37,971.20 ($38,015.57 – $44.37 in fees)
• 10-year index fund portfolio value = $93,660.10 ($93,872.92 – $212.82 in fees)
• 20-year index fund portfolio value = $295,117.56 ($296,537.53 – $1,419.97 in fees)
• 30-year index fund portfolio value = $728,440.95 ($734,075.21 – $5,634.26 in fees)
• 40-year index-fund portfolio value = $1,660,494.54 ($1,678,686.24 – $18,191.70 in fees)

Robo-advisor vs. target-date fund

While robo-advisors build a portfolio of individual ETFs and funds, a target date fund is a single fund that owns a diversified mix of investments that adjust over time.

Both robo-advisors and target date funds are designed to adjust as you get older, moving your investments from aggressive to conservative. And both help investors plan for retirement. But while robo-advisors charge a 0.25% annual fee (plus underlying fund fees), target date funds charge only about 0.1%.

Here’s how they compare:

Robo-advisor ($500/mo invested, 6% return, 0.25% fee):

• 5-year index fund portfolio value = $35,589.26 ($35,851.91 – $262.65 in fees)
• 10-year index fund portfolio value = $82,656.72 ($83,829.86 – $1,173.14 in fees)
• 20-year index fund portfolio value = $27,227.97 ($233,956.36 – $6,728.39 in fees)
• 30-year index fund portfolio value = $480,091.21 ($502,810.06 – $22,718.85 in fees)
• 40-year index-fund portfolio value = $922,363.22 ($984,286.10 – $61,922.88 in fees)

Target-date fund ($500/mo invested, 6% return, 0.1% fee):

• 5-year index fund portfolio value = $35,746.64 ($35,851.91 – $105.27 in fees)
• 10-year index fund portfolio value = $83,358.50 ($83,829.86 – $471.36 in fees
• 20-year index fund portfolio value = $231,238.51 ($233,956.36 – $2,717.85 in fees)
• 30-year index fund portfolio value = $493,581.27 ($502,810.06 – $9,228.79 in fees)
• 40-year index-fund portfolio value = $958,983.74 ($984,286.10 – $25,302.36 in fees)

Robo-advisor vs. financial advisor

How do robo-advisors and financial advisors stack up? Robo-advisors perform a lot of similar functions as a financial advisor. Portfolio planning, rebalancing, goal setting, and even tax planning are available at most major robo-advisor services.

Financial advisors do all of these things, but they also can help answer specific questions you may have about the plan, and make adjustments based on your preferences. And financial advisors actively manage your money, while robo-advisors do it based on algorithms and pre-set rules.

There are pros and cons to each service, but here’s how the returns might compare:

Robo-advisor ($500/mo invested, 6% return, 0.25% fee):

• 5-year index fund portfolio value = $35,589.26 ($35,851.91 – $262.65 in fees)
• 10-year index fund portfolio value = $82,656.72 ($83,829.86 – $1,173.14 in fees)
• 20-year index fund portfolio value = $227,227.97 ($233,956.36 – $6,728.39 in fees)
• 30-year index fund portfolio value = $480,091.21 ($502,810.06 – $22,718.85 in fees)
• 40-year index-fund portfolio value = $922,363.22 ($984,286.10 – $61,922.88 in fees)

Financial advisor ($500/mo invested, 6% return, 1% fee):

• 5-year index fund portfolio value = $34,811.48 ($35,851.91 – $1,040.43 in fees)
• 10-year index fund portfolio value = $79,240.72 ($83,829.86 – $4,589.14 in fees)
• 20-year index fund portfolio value = $208,315.51 ($233,956.36 – $25,640.85 in fees)
• 30-year index fund portfolio value = $418,564.74 ($502,810.06 – $84,245.32 in fees)
• 40-year index-fund portfolio value = $761,038.58 ($984,286.10 – $223,247.52 in fees)

Pros

• Low fees compared to financial advisors
• Diversified investment approach
• Access to goal setting and tax planning tools
• Avoids high-cost funds

Cons

• Can’t customize very much
• Can’t always speak to a professional for help
• Fees may be high compared to investing yourself

The best robo-advisors are a great way for hands-off investors to build an investment portfolio without paying the high fees of a financial advisor.

But if you are a do-it-yourself (DIY) investor who likes to pick and choose your investments, you’ll feel handcuffed by a robo-advisor’s lack of flexibility. And if you find that you can’t handle the ups and downs of the stock market and constantly watching your investments fluctuate in value, you may benefit from finding a fee-only financial advisor.