Robo-advisors: The basics and key considerations for investors
E*TRADE Capital Management, LLC06/24/21
Summary: Robo-advisors leveled the playing field and made professional money management more accessible to people regardless of their income or size of their portfolio. We dive into five features to consider before diving in.
What is a robo-advisor?
In the past few years, many financial companies have begun to offer robo-advisors, also commonly known as “robos", “online advisors", or “digital advisors”. The E*TRADE from Morgan Stanley robo-advisor is Core Portfolios.
If you decide to use a robo-advisor, the first step is to take a short online survey evaluating your financial goals, risk tolerance, and investing time horizon to identify an appropriate portfolio strategy and asset allocation. While these portfolio strategies can vary, they generally fall into one of three general categories—conservative, moderate, or aggressive.
Lower risk and potential return
Medium risk and potential return
Higher risk and potential return
After you select the asset allocation and enroll in the product, technology helps automatically invest and manage your assets—a feature new investors may find to be an advantage. Robo-advisors typically invest in exchange-traded funds (ETFs) to give investors broad diversification with low underlying expenses. They select different types of ETFs to help manage investment returns and market risk with diversification.
It's no secret that markets tend to zig and zag, and robos factor this in as well. So, if your portfolio's target allocation fluctuates too far outside your desired asset allocation, the portfolio is rebalanced to get back to its original targets.
Considering a robo?
Now that you have an overview of how robos work, the natural follow-up question is: Is it right for me? You can learn about a robo-advisor’s fundamental features in a document called a Form ADV. It outlines the fees, asset allocations, and investment vehicles, which can vary greatly among financial firms. Generally, here are five features to consider before diving in:
- Affordability. Investors pay relatively low fees for robo-advisors. To put it in perspective: A human advisor typically charges an annual fee of 1%–2% of a client's total account balance, whereas a typical robo's advisory fee ranges from 0.25% to 0.5%. For example, if you had $1,000 in your account with a 0.25% annual fee, your cost would be $2.50 per year (versus $10 per year with a 1% fee).
Robos also tend to have small account minimums, making it easier for newer investors to start investing. For example, E*TRADE Core Portfolios have a minimum investment requirement of $500.
Investors might also see lower costs in part because robo-advisors often invest in ETFs, which generally have lower expense ratios than mutual funds. Finally, many robo-advisors offer tax strategies to help you keep more of your assets and pay lower taxes.
- Automation. Robo-advisors do require some initial human decision-making to construct the portfolios. After that, automated technology helps your portfolio stay on track. This removes the human emotion in building and managing a portfolio. Relying on a mathematical algorithm to make rebalancing decisions, instead of emotions, can help you avoid taking unnecessary risks, especially during times of market volatility.
The automated technology also allows you to be more hands-off, which is ideal for many beginner investors who may not feel comfortable making regular investing decisions. You can sit back, knowing that the portfolio is being invested and monitored based on the profile.
- Customization. Robo-advisors are not a one-size-fits-all solution. They allow you to customize. You can develop a portfolio based on your personal risk tolerance, the amount and frequency you want to invest, and your investing time horizon (i.e., how long you want your money invested). Robo-advisors also can offer enhancements such as socially responsible investing (SRI) investments that match your values, whether you prioritize the environment, community development, corporate responsibility, or other causes.
Investors who prefer smart beta investments can also use robo-advisors to achieve their strategies. Smart beta ETFs try to outperform their benchmark index by favoring securities with certain features.
- Long-term focus. Many robo-advisors are designed for long-term investors because you typically see the benefits from routine automated investing over months and years, not immediately. So, they can provide several advantages for new investors who want to start building a portfolio. Robos are not ideal for active professional traders or day traders looking for quick gains.
- Accessibility. Robos are digital in nature, making them favorable for investors who want to manage their finances online. Robos make it seamless to open an account, select desired investments, and monitor a portfolio all with a mobile device or on your computer.
Robos offer a primarily digital experience, but some—like Core Portfolios—offer “hybrid" services, providing access to human support when you need it. When it comes to investing, you will undoubtedly have questions along the way. Real-time access to an investment professional is a valuable resource, especially for someone who is getting started with investing.
Bottom line: The automated approach, ease of use, lower entry point, and low fees inherent to a robo-advisor make it a potentially attractive investing strategy for new investors.
How can E*TRADE help?
With Core Portfolios, we’ll build, manage, and rebalance a diversified ETF portfolio for you, including portfolios with socially responsible ETFs.
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