Once novel, now standard: Robo-advisors have cemented their place in the investment management landscape.
Many old-hat brokers now have an online advice arm, including Vanguard, Charles Schwab, Fidelity and E-Trade. Independent offerings like Betterment and Wealthfront have been lapping up assets.
These companies are bringing financial advice to the masses by charging rock-bottom management fees for services that once were available only to the wealthy: things like customized asset allocation, automatic rebalancing and tax-loss harvesting.
If you’re thinking of joining in on that momentum, the first step is deciding which online advisor is best for you. It’s an increasingly crowded field, with options that range from complete automation — robo-advisors in the true sense of the word — to hybrids that pair computer algorithms with financial advisors. To narrow it down, consider the following criteria.
Robo-advisors typically charge an annual management fee that is assessed as a percentage of your invested assets. If the fee is 0.25% per year, you’ll pay $25 on a $10,000 balance. Every dollar you pay toward fees is a dollar you don’t get in investment returns.
Some advisors, like Wealthfront and SigFig, manage a portion of your assets for free. If you have only a small amount to invest, you might consider starting there.
So why wouldn’t everyone pick SoFi or Schwab Intelligent Portfolios if their services are free? The answer is that fees are just one piece of the online advisor puzzle. You also want to consider the services the advisor provides, some of which have the potential to improve your returns, which could make up for any fee differential.
Automatic rebalancing, tax-loss harvesting and portfolio allocation according to your goals and risk tolerance typically come standard. Other services may be specific to the advisor. For example, Wealthfront offers direct indexing on accounts of $100,000 or more, which allows an even bigger tax advantage by investing in individual securities. Acorns links your credit and debit cards to round up your purchases, investing the change into a robo-advisor-managed portfolio. And Betterment has a behavioral finance focus, with lots of goal-based tools designed to motivate you to save more. Some robos offer socially responsible investing options, which can make a positive impact on the world while you invest.
Robot vs. human advice
Then there are advisors that supplement their computer modeling with real live humans, either in the form of a rotating cast of financial advisors that changes each time you call or by offering clients dedicated advisors. The latter, as you might imagine, is typically more expensive.
Often, you’ll pay a little bit more for a hybrid service or be subject to an increased minimum. Personal Capital, for example, charges 0.89% and offers clients with $200,000 or more two dedicated financial advisors. Other clients get access to a team.
The credentials these advisors have vary — some are registered investment advisors, some full-fledged certified financial planners — so be sure to compare and contrast on that point as well. Note, too, that the amount and kind of access you receive may be limited.
These companies are still too young to make accurate judgments on performance. They’ve existed almost entirely in a bull market, and any outperformance by one advisor over another could easily be attributed to the asset classes the advisor has weighted more heavily, rather than a long-term track record of success. (And there are many reasons why robo performance is just one piece of the puzzle.)
But you can judge the investment options the advisor offers. One way is by looking at the expense ratios of those investments. These fees go to the investment fund companies — the index funds and exchange-traded funds used in your portfolio — not the robo-advisor, though in some cases they are one and the same. For instance, a firm that has proprietary funds, such as Vanguard, Schwab or Fidelity is likely to use many of those funds in its robo-advisor portfolios. Your goal is to keep these expense ratios as low as possible.
Most robo-advisors invest exclusively in exchange-traded funds, with expense ratios that generally average under 0.20%. When evaluating online advisors, look at the total cost — management fees plus average expense ratios — to get a full picture of what is coming out of your wallet. You should also look at the number of asset classes included in the portfolios used and the percentage of your investment allocated to cash. You can find this information on the robo-advisor’s website, during the sign-up process or by calling the advisor directly.
Online advisors have account minimums ranging from $0 to as much as $100,000, so this is a key component of the decision process. If you’re starting fresh, you’ll want to look for an advisor with no minimum. In general, the greater level of personalized service, like a dedicated financial advisor, the higher the minimum initial investment.
Types of accounts managed
With the exception of Blooom, which specifically deals in 401(k)s, most online advisors cater to IRAs and taxable accounts. If you have a 401(k) that offers matching dollars, prioritize that account first, because that match is a guaranteed return on your investment.
Once you’ve captured the match, consider opening an IRA with an online advisor. Taxable accounts at robo-advisors should be used if you’ve maxed out your 401(k) and IRA contributions or for longer-term savings goals, like a down payment on a home.