Robo Etfs: Worth The Investment?

Robo-advisors are online investment advisors that use computer algorithms to manage your money. They select investments, automatically rebalance your portfolio, and look for tax-loss harvesting opportunities. They are a type of digital financial advisor that provides automated, algorithm-driven financial planning and investment services without human supervision. The first step in using a robo-advisor is taking an online survey that evaluates your financial goals, risk tolerance, values, and investing time horizon. This helps identify an appropriate investment strategy and asset allocation for you. Robo-advisors typically invest in exchange-traded funds (ETFs) to give investors broad diversification with low underlying expenses. They are a good option for investors with smaller amounts of money to invest due to their reasonable fees and low minimum deposit requirements. However, they may carry higher fees than ETFs.

Robo-advisors vs. index funds

Robo-advisors and index funds are both low-cost investment strategies, but they differ in several key ways. Here are the factors to consider when comparing Robo-advisors vs. Index Funds:

Level of User Involvement

Robo-advisors offer automated portfolio management, whereas investing in index funds requires you to manually create and balance your own portfolio for optimal diversification. With a robo-advisor, you answer questions about your financial goals, risk tolerance, and investment time horizon, and the platform constructs and manages a diversified portfolio for you. This makes robo-advisors ideal for those seeking a hands-off approach or who lack the time or expertise for portfolio management. Index funds, on the other hand, give you more control over your investments but require a higher level of financial knowledge and ongoing commitment of time and analysis.

Costs

Robo-advisors typically charge an annual fee based on assets under management (AUM), such as 0.25% per year. Additionally, investors are subject to the expense ratios of the funds the robo-advisor invests in. Index funds, on the other hand, have low expense ratios, historically averaging around 0.52%. While robo-advisors may seem more expensive, they can still be cost-effective for those who want a hands-off approach without the time or expertise to manage their own portfolio.

Flexibility and Customization

Robo-advisors generally invest in low-cost index funds and ETFs to diversify across geographies and asset classes. While this provides good diversification, it may lack the flexibility and customization that managing your own portfolio of index funds affords. With index funds, you can choose which funds to include in your portfolio, determine their relative weightings, and decide when to rebalance. This gives you more control over your investment strategy but requires more active involvement.

Historical Performance

Index funds have a longer history of performance that can be evaluated, whereas robo-advisors are relatively new. Mutual funds, which are similar to index funds in that they are managed by humans, have a track record of good performance and are managed by experienced professionals with high levels of financial intelligence. Robo-advisors, on the other hand, operate based on algorithms and mathematical formulas, and there is limited data to evaluate their long-term performance.

Suitability

The suitability of robo-advisors vs. index funds depends on your individual circumstances, investment goals, and preferences. If you are looking for a hands-off approach, prefer not to make regular investment decisions, or lack the time and knowledge to actively manage your investments, a robo-advisor may be a better option. Index funds may be more suitable if you enjoy being hands-on with your investments, want more control over your portfolio's composition and risk level, and have the necessary financial knowledge and time commitment.

Robo-advisors vs. target-date funds

Robo-advisors and target-date funds are both popular investment options for people looking for a hands-off way to build and manage their portfolios. However, they are designed for different situations and achieve this goal in different ways. So, which is the right choice for you?

Robo-advisors are online investment advisors that use computer algorithms to manage your money. They select investments, automatically rebalance your portfolio, and look for tax-loss harvesting opportunities. They typically invest in low-cost exchange-traded funds (ETFs) and charge an advisory fee, usually around 0.25% of your assets under management. Robo-advisors offer more personalisation than target-date funds as they consider factors such as age, income, current savings, risk tolerance, and goals. They are also more flexible, allowing investors to target multiple goals simultaneously, such as saving for a home or education. Additionally, robo-advisors can use advanced investment strategies like tax-loss harvesting, which can increase returns. However, they tend to charge higher fees than target-date funds.

Target-date funds (TDFs), on the other hand, are designed specifically for retirement savings. They are mutual funds that adjust their holdings over time to reduce volatility and risk as the target retirement date approaches. An investor chooses a fund with a target date close to their planned retirement year, and the fund automatically shifts its asset allocation. Target-date funds are typically overseen by fund managers and only charge an expense ratio, which can make them a cheaper option than robo-advisors. However, they offer less personalisation and are less flexible, as they are mainly designed for long-term retirement savings.

When deciding between a robo-advisor and a target-date fund, consider your financial goals and situation. If you have a simple financial situation and are only saving for retirement, a target-date fund could be a good choice due to its low cost and simplicity. On the other hand, if you have a more complex financial situation and want to target multiple goals, a robo-advisor might be a better fit, despite the higher fees.

Pros and cons of robo-advisors

Robo-advisors are online investment advisors that use computer algorithms to manage your money. They are a type of digital financial advisor that provides automated, algorithm-driven financial planning and investment services without human supervision. They are designed to help investors build customised portfolios based on their financial goals, risk tolerance, income, current savings, and investment horizon.

Pros of Robo-Advisors:

• Low-cost alternative to human financial advisors: Robo-advisors typically charge lower fees than human financial advisors, making professional money management more accessible to people with lower incomes or smaller portfolios.
• Personalised portfolios: Robo-advisors use algorithms to deliver personalised investment planning services, taking into account an individual's financial goals, risk tolerance, and other factors.
• Automated decision-making and portfolio rebalancing: Robo-advisors automate investment decisions by recommending a portfolio customised to help meet investment goals. They also automatically rebalance your portfolio when it deviates from your desired asset allocation.
• Strategies like tax-loss harvesting: Some robo-advisors can automate tax-loss harvesting, selling assets at a loss to offset taxable gains on other investments.
• Ease of use and accessibility: Robo-advisors are digital platforms that make it seamless to open an account, select investments, and monitor your portfolio using a mobile device or computer.

Cons of Robo-Advisors:

• Limited set of investments and strategies: Robo-advisors may not offer the same range of investment options and strategies as human advisors.
• Lack of human touch: Robo-advisors lack the personal connection and empathy that human advisors can provide. They may not be able to see the full picture when analysing an individual's financial situation and may not be suitable for complex financial situations.
• May not be suitable for active traders: Many robo-advisors are designed for long-term investors and may not be ideal for active professional traders or day traders looking for quick gains.

Pros and cons of ETFs

Exchange-traded funds (ETFs) are a powerful type of investment that has become an alternative to mutual funds. They are considered low-risk because they are low-cost and hold a basket of stocks or other securities, increasing diversification.

Pros of ETFs

ETFs have lower expense ratios than other types of investments. They are also more tax-efficient than mutual funds, as there are fewer trades, which cause capital gains and losses. ETFs are also more flexible, as they are traded throughout the day, giving investors more control.

ETFs are also more diversified, typically offering exposure to the total stock market. This means investors are not overly reliant on one company or industry.

They are also more cost-effective than mutual funds due to their structure. ETFs are not actively managed, so managers are only buying and selling what is needed to keep the ETF tracking its intended investment mix.

Finally, ETFs are more liquid, economical, and flexible than mutual funds.

Cons of ETFs

ETFs still have costs, including trade fees and expense ratios.

ETFs may also limit investors in terms of available investments. For example, investors may not be able to access mid or small-cap companies, and thus have fewer growth opportunities.

ETFs may also not be ideal for hands-on investors who want to be selective about the companies they invest in. For example, some people refuse to invest in companies that sell meat products or cigarettes.

Additionally, ETFs might be more affordable than mutual funds, but the returns may be lower than high-yielding stocks.

How to choose between robo-advisors, target-date funds and index funds

Robo-advisors, target-date funds and index funds are all investment options for those who want a hands-off approach to investing. But how do you choose between them? Here are some factors to consider:

Level of Involvement

Even with a hands-off approach, you should always keep an eye on your money. That being said, both target-date funds and robo-advisors allow you to be pretty hands-off once the initial setup is complete. Index funds will require some light supervision. Robo-advisors give you the added benefit of knowing that a computer is checking in on your investments daily to make sure things are on track.

Cost

Robo-advisors tend to charge around 0.25% of your assets under management. So, if you had $10,000 managed by a robo-advisor, you'd have to pay a $25 management fee for that year. That fee is on top of whatever expense ratios are charged by the funds you're invested in through your robo-advisor.

Index funds, on the other hand, only require you to pay the expense ratios, and many index funds charge very low expense ratios compared to other funds.

Target-date funds have an expense ratio that includes the fees of the underlying funds it invests in. Although fees for target-date funds vary, they typically average about 0.73%, according to Morningstar, and run even lower at Vanguard, where the average target-date fund expense ratio is 0.17%.

Control

If you want more control over your asset allocation, a robo-advisor might be the best option for you. Target-date funds won't let you fine-tune your allocations. Robo-advisors, on the other hand, will assign you a diverse portfolio of exchange-traded funds and create an asset allocation for you, which you're free to adjust at any time.

Availability

If you're primarily investing in a 401(k), that settles the debate: most robo-advisors won't manage your 401(k)—you'll need to open a separate IRA or taxable account. Nearly all 401(k)s offer target-date funds as an investment option, and it's likely your best hands-off choice within that type of account.

Frequently asked questions