What Is A Robo-Advisor? Definition and How It Works - NerdWallet (2024)

If you’ve ever wished for a robot to clean your house or walk your dog, you’ll likely understand the appeal of a robo-advisor. These services don’t do windows or pet-sit, but what they offer is arguably more valuable: a relatively hands-off way to invest.

Robo-advisor definition

Robo-advisors — also known as automated investing services — use computer algorithms and software to build and manage your investment portfolio. Services can include automatic rebalancing and tax optimization, and require little to no human interaction — but many providers have human advisors available for questions.

Traditional portfolio management services often require high balances; robo-advisors typically have low or no minimum requirement. Because of that and their low costs, robo-advisors let you get started investing quickly — in many cases, within a matter of minutes.

Human financial planners also are not particularly diverse. Among the 96,412 certified financial planners reported in 2023, only 23.7 % were women and less than .1% were nonbinary. The majority of all CFPs — 82.5% — are white. If you want, but can't find, a human advisor who fits your needs and values, a robo could be an alternative for you. For example, HBCU Legacy is a robo-advisor geared toward students and alumni of historically Black colleges and universities, and Ellevest is a robo-advisor geared toward women investors.

» Ready to get started? Check out NerdWallet's picks of best robo-advisors

Are robo-advisors worth it?

When considering whether a robo-advisor is worth it, take into account the following:

Robo-advisor fees and account minimums

Robo-advisors are much cheaper than an-person human financial advisor. Most companies charge between 0.25% and 0.50% as an annual management fee, though there are even free options such as Sofi Automated Investing.

As with many other financial advisors, fees are paid as a percentage of your assets under the robo-advisor’s care. For an account balance of $10,000, you might pay as little as $25 a year. The fee typically is swept from your account, prorated and charged monthly or quarterly.

You won’t usually pay transaction fees with a robo-advisor. In a standard brokerage account, you might pay a commission to buy or sell investments, both during a rebalancing of your portfolio and when you deposit or withdraw money. Robo-advisors frequently waive these charges.

Some robo-advisors require $5,000 or more as an initial investment, but some have no required account minimum, and others have account minimums of $100-$500.

Automated investing vs. hands-on investing

If you want to start growing your wealth, but you're not quite sure how to get started, robo-advisors can be one way for beginners to start investing. When you sign up with a robo-advisor, your first interaction will almost always be a questionnaire, designed to find out your risk tolerance, goals and investing preferences.

Instead of you researching which stocks or funds to buy, robo-advisors largely build their portfolios out of low-cost exchange-traded funds (ETFs) and index funds, which are baskets of investments that aim to mirror the performance of a stock market index, such as the. You’ll pay the fees charged by those funds — called expense ratios — in addition to the robo-advisor's management fee.

Robo-advisors generally offer between five and 10 portfolio choices, ranging from conservative to aggressive. The service’s algorithm will recommend a portfolio based on your answers to the questionnaire, but you should be able to veto that recommendation if you’d prefer a different option.

If you'd prefer to pick your own investments, opening a brokerage account might be a better option. You can find online stock brokers who offer $0 account minimums and free trades. You'll have to do the research on stocks yourself, and manage your own portfolio, but you'll skip some of the fees that can come with robo-advisors. (Read our primer on how to invest in stocks for more on DIY investing.)

Is a robo-advisor right for you?

That depends. Do you want to be a hands-on investor? Or do you prefer a hands-off approach? If you want to set it and forget it, a robo-advisor might be a solid choice.

The formula for many advisors is the same: automate investment management so it can be done by a computer at a lower cost. At most robo-advisors, you can expect:

Most robo-advisors manage both individual retirement accounts and taxable accounts. Some also manage trusts, and a select few will help manage your 401(k). It comes down to whether you want automated portfolio management or not.

And if you don't want to manage your own portfolio, but you want or need more comprehensive financial planning than a robo can provide, here's one middle ground option: online financial planning services.

What are online planning services?

These companies operate as online financial advisors, and they're sort of a robo-advisor, traditional advisor hybrid: You'll receive unlimited access to a team of financial planners (or in many cases, your own dedicated financial advisor), but you'll meet virtually via phone or video rather than in-person. This model means you get human oversight and interaction at a higher cost than a robo, but at a lower cost than a traditional financial advisor.

You can expect the cost and minimum investment requirements of online financial advisors to increase with the level of human involvement, certification (such as access to a certified financial planner) and personalization:

These hybrid services can be an additional option because they at least partially fill in the major gap left by strictly digital robo-advisors: Some investors want, and need, human interaction.