How to Choose a Robo-Advisor, and When a Trader Would Use One
A robo-advisor runs a portfolio for you with software. If you already trade, ask what it costs in total, what it does automatically, and whether those automatic trades can collide with yours.
What to compare: robo-advisors
- Add the advisory fee to the expense ratios of the funds it buys The advisory fee comes on top of what the underlying funds already take. Only the two together tell you what the account costs each year.
- Check its adviser registration on the SEC's adviser search A robo-advisor is an investment adviser. The SEC's Investment Adviser Public Disclosure site shows its registration, its Form ADV and any disciplinary history.
- Read the Form ADV Part 2 brochure all the way through The brochure covers fees, conflicts of interest, how portfolios are built and whether the firm makes money from the funds it picks for you.
- Learn how its tax-loss harvesting works, and if you can switch it off Harvesting inside the robo account can't see your trades elsewhere, so a sale there and a purchase in your trading account can add up to a wash sale.
- Check minimums and which account types it offers Some services want a minimum balance before certain features switch on. Make sure the account types you want, such as an IRA or a joint account, are supported.
- Ask about access to a human adviser, and the cost Some services offer planners by phone or video, sometimes only at a higher tier. Find out what you get before you need it.
- Read the rebalancing rules and how cash is handled Know how far the portfolio can drift before it rebalances, and what happens to cash sitting in the account between trades.
A robo-advisor is an investment adviser that uses software to do what a human adviser has traditionally done for a portfolio. You answer questions about goals and risk. It picks an allocation, usually from a menu of index funds or exchange-traded funds, buys them, and then keeps the mix on target by rebalancing whenever market moves push one part of the portfolio too far from its intended weight. Many also run tax-loss harvesting in taxable accounts: they sell positions that are down to realize a loss and buy something similar so the portfolio stays invested.
That’s the whole product. Services differ on cost, on how the automatic trades get made, and on who stands behind them, and you can check each of those in documents the firm is required to publish.
Why a trader might want one
Plenty of active traders keep two pots. One is the trading account, run by hand, with positions opened and closed on a view. The other is long-term money nobody should be touching on a bad afternoon.
A robo-advisor can hold that second pot. It enforces a plan you’d otherwise have to enforce yourself.
You give up control, and you pay an annual fee.
Add up the real cost
A robo-advisor usually charges an advisory fee as a percentage of assets, taken in small pieces through the year, while the funds it buys charge their own expense ratios, which come out of fund returns before you ever see them. They’re separate charges, so the figure that matters is the sum.
The percentages look small. They compound against you for every year the money stays invested.
Some services charge a flat monthly subscription in place of a percentage, so check for that too. On a small account a flat fee can cost more as a share of assets than a percentage fee would, and on a large one it can cost less. Say a hypothetical flat fee is 5 a month. That’s 60 a year: 1.2% of a 5,000 account, and 0.06% of a 100,000 one.
Tax-loss harvesting and your own trading
If you also trade, this section probably matters more to you than any other.
The IRS wash sale rule disallows a loss when you buy a substantially identical security inside a window running 30 days back and 30 days forward from the sale date, and it looks across all of your accounts, including IRAs, and at purchases by your spouse, so a robo-advisor that harvests a loss in one account while you buy the same fund or stock in another can leave you with a loss the IRS won’t allow that year. The robo account can’t see your trading account, so it has no way to stop this for you.
Before you sign up, get answers on three points. Which funds does the service use as replacements when it harvests? Can you exclude specific securities? Can you turn harvesting off entirely?
The overlap risk is higher if your trading account holds broad index funds. Keep a list of what the robo account holds and check it before you trade the same names. The wash sale window calculator shows the dates to watch around any sale.
Registration and paperwork
Robo-advisors are investment advisers, registered with the SEC or with a state securities regulator depending on their size, which means they owe you a fiduciary duty and must file Form ADV.
Look the firm up on the SEC’s Investment Adviser Public Disclosure site, which shows registration status, the firm’s Form ADV and any disciplinary events. Then read Part 2 of Form ADV, the brochure. It goes through fees in detail, conflicts of interest, and whether the firm or an affiliate earns anything from the funds it puts you in.
If the adviser uses its own affiliated funds, the brochure has to say so. That paragraph deserves a slow read.
Minimums, account types and people
Compare minimum deposits, the account types on offer, and whether you can hold more than one goal-based portfolio. Also check whether you can transfer existing holdings in or have to sell them first, since selling in a taxable account can trigger gains.
Human access varies widely. Some services include planners, some charge extra, and some have none at all. Decide whether you want a person on call before you compare prices.
Red flags
- The firm doesn’t appear on the SEC’s adviser search.
- The fee page never mentions fund expense ratios.
- Harvesting can’t be switched off.
- Transfers out carry heavy charges or require selling everything first.
- Performance claims that don’t say how they were calculated, what period they cover or whether fees came out.
Next to a trading account
A robo-advisor does one job, holding a diversified portfolio on autopilot. It won’t place a stop, pick a tax lot, or react to news. For the trading side you still need a broker chosen on its own merits, which is what how to choose an online broker covers. If you run both, keep the holdings of each written down, decide in advance which account owns which kind of position, and check the list before any sale in either one, because the tax rules treat them as one person’s trades whether the software does or not.
Also asked
- Can a robo-advisor lose money?
- Yes. It invests in market funds, so the account rises and falls with them. Automation changes who makes the decisions, and the market risk stays exactly where it was.
- Is a robo-advisor account protected like a brokerage account?
- The securities are usually held at a custodian broker, so ask which one and whether it's a SIPC member. SIPC protection covers custodian failure, never investment losses.