What is a Robo-Advisor? - dummies

By Matt Krantz

Robots are entering the financial world. So-called robo-advisors are essentially online tools programmed to pick the perfect portfolio for you. You log in to the robo-advisor and tell the computer how much risk you can stomach and your financial goals. The algorithm spits out a recipe of what exchange-traded funds (ETFs) you should own. Some robo-advisors can even buy the ETFs for you.

Robo-advisors are trying to serve investors who have simple investment needs but are still looking for help. Robo-advisors charge fees, but they’re a fraction of what it would cost to hire a human financial advisor. However, you can still save yourself tons of money, especially over the long-term, if you pick your own ETFs and buy them yourself.

The term robo-advisor is more applicable to some providers than others, because with some of these services you don’t have to do much more than sign up and put in money. Many younger investors with simpler portfolio needs have gravitated to these services because they’re quick, simple, and online.

Robo-advisors that hold your hand

If you would like to tap the wisdom of a financial robot but are not willing to hand over the keys completely to HAL yet, robo-advisors that make recommendations might be for you. With these robo-advisors, you enter your portfolio goals and then receive a recommended portfolio of ETFs. It’s up to you to make the decisions and execute the trades.

Following are a few examples of robo-advisors that make recommendations but don’t carry them out:

  • MarketRiders is aiming to not only design your asset allocation but also to choose the specific ETFs that can put the plan in motion. You enter some basic information about yourself and your financial goals, and the site generates an asset allocation plan and recommends ETFs. If your asset allocation falls out of balance — say if one type of investment does better than the others — the site tells you which ETFs to sell and which ones to buy to get back in balance. You still need to log on to your brokerage account and do the buying and selling as suggested by MarketRiders’ instructions, though. You also pay a fee, $14.95 a month.
  • Invest-it-Yourself.com brings an à la carte approach to ETFs. You can choose from three menus of portfolios: standard, advanced, and premier. The standard portfolio recommends four asset classes and four corresponding ETFs, the advanced portfolio recommends eight ETFs, and the premier recommends nine ETFs. The system is free, but you’ll be offered additional advisory services that do cost money. Just as with MarketRiders, you need to log on to your brokerage account and do the buying and selling of the ETFs recommended by Invest-it-Yourself.com, unless you sign up for more personalized assistance.
  • Morningstar Model Portfolios is like a giant cookbook of recipes for which ETFs to buy. You’ll find model portfolios complete with a list of ETFs to buy if you’re a retiree or a saver. Morningstar also modifies the allocations for aggressive or conservative investors.
Morningstar ETF information page
You can find all sorts of particulars about ETFs at Morningstar’s ETF information page, including the all-important management fee.

Robo-advisors that are completely automated

If you’re comfortable with the idea of handing over your portfolio to a machine, you can choose among the completely autonomous robo-advisors, which pick your ETFs and buy them. These services are designed to completely automate the process of picking ETFs, buying them, and keeping them in balance. There are some catches, namely the fees and the lack of control, but for beginning investors or people who want to hand over the keys to someone, they can be great options. Some examples include the following:

  • Schwab Intelligent Portfolios isn’t the first turnkey robo-advisor, but it is certainly the one making the biggest impact. When one of the largest online brokers in the world – and one that caters to the do-it-yourself investor – unveils a robo-advisor, the world takes notice. Schwab’s system assesses your taste for risk and then builds a portfolio of up to 20 different asset classes. Even more stunning: The service is free. It doesn’t charge advisory fees or commissions. The service also helps you sell losers at tax time, giving you tax losses that can be used to cut your taxes.

Does Schwab Intelligent Portfolios sound too good to be true? A couple of drawbacks exist. First, you’ll need to trust the machine’s selection of ETFs. But a more important consideration is a hidden fee. One of the asset classes Schwab Intelligent Portfolios can choose is cash. That’s right, part of the money you’ve invested in the portfolio can be held in greenbacks, on which you get no return. Allowing cash to sit in your brokerage account collecting no interest and not appreciating can be pretty costly. This hidden fee is something investors need to be aware of — and a big reason why you can still beat the Intelligent Portfolios by choosing your own investments.

  • Personal Capital is best known for its great account tracking tools, but it’s also a robo-advisor. But the site will also help you build an appropriate portfolio crafted from ETFs as well as individual stocks where appropriate. The site’s account tracking service is free, but the ETF recommendation service costs 0.89 percent annually up to $1 million invested.
  • E*Trade Prebuilt Portfolios is another example of a model where an online broker recommends a portfolio and suggests specific ETFs that can work. Portfolio Builder recommends three portfolios: conservative, aggressive, and moderate. The system doesn’t charge a commission but does park some of your portfolio in cash at no return.
  • Wealthfront is targeting investors who want to enjoy the benefits of ETFs but want to leave most of the work to someone else. Simply answer a few questions on Wealthfront’s website, including how much you have to invest and your age, and the site not only will choose ETFs for you but buy and manage them, too. However, this service comes a cost. Wealthfront takes a cut of your portfolio to the tune of 0.25 percent of your assets a year. That amount is less than the 1 percent charged by many human advisors, but you’re not getting the personal touch, either. Then again, this service is for investors who don’t want a personal touch.
  • TD Ameritrade’s Managed Portfolios is another major broker’s entrance in the robo-advisor race. The brokerage, best known for its tools for active investors, provides off-the-shelf tools for people who just want to automate everything. The Essential Portfolios are the simplest way to build an ETF portfolio and the service costs 0.3 percent a year.
  • Betterment is another site trying to appeal to ETF investors who want someone else to choose their ETFs and are willing to pay for the convenience. The site has added features to give more control to people who want to be a little more hands-on as well. To use Betterment, you answer questions about your financial goals, and the site creates a collection of ETFs deemed to be ideal for you. The site will then buy and manage those ETFs for you. Depending on the size of your initial deposit, Betterment takes anywhere between a 0.25 percent and 0.4 percent cut of your portfolio a year as a fee. Need more help? If you pay the 0.4 percent fee, you get access to a team of investment professionals to help you.

These automated robo-advisors might seem appealing. They can be a great solution if you’ve decided you’re not interested in managing your money yourself because you don’t have the time or interest. These robo-advisors are better than doing nothing — and can be perfect if they urge you to get started. But frankly, you can do better yourself. Most investors can set up an account at a brokerage account with no-commission ETFs, buy the ETFs themselves, and save at least 0.1 percent a year, if not more. That savings adds up over time. Robo-advisors also aren’t right for investors who are looking for exposure to some off-the-beaten-path corners of the market.