What is a Robo-Advisor?

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Dana Anspach Updated June 17, Robo advisors are automated portfolio managers.

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You can think of them as an autopilot for investors. After initially answering a series of questions about an investor's resources and financial goals, the robo advisor will make ongoing decisions about how to invest the client's money. Here's what these products offer, how they work, and whether they could be a good fit for your investing strategy.

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What Are Robo Advisors? Robo advisors are software products that can help you manage your investments without the need to consult a financial advisor or self-manage your portfolio.

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These products are offered by a wide variety of financial institutions. Some, such as Fidelity, are established financial companies with a lengthy history. Others, like Acorns, were created recently for the sole purpose of providing a robo advisor service.

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Robo advisors are an alternative to traditional financial advisors, and they're usually a cheaper option. They're also an alternative to an investor simply picking and choosing investments on their own.

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How Robo Advisors Work A new customer signing up for a robo advisor usually starts by supplying basic information about their investment goals through an online questionnaire. These questions may touch on subjects like your investment timeline, your risk tolerance, and how much money you have in savings. Robo advisors then run those answers through an algorithm to provide an asset allocation approach and build a portfolio of diversified investments that meets your goals.

Robo-advisors that hold your hand

Once your funds are invested, the software can automatically rebalance your portfolio to ensure that it remains close to that target allocation. Many popular robo advisors encourage investors to regularly contribute binary option demo account lionstone their accounts, such as small weekly deposits.

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The robo advisor will use those contributions to maintain target allocation. Some robo advisors even use tax-loss harvesting strategies, which involves selling certain securities at a loss to offset gains in other securities.

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Investments In a Robo-Managed Account Most robo advisors use mutual funds or exchange-traded funds rather than individual stocks to build your portfolio. They typically follow an index fund or another passive investment approach based on modern portfolio theory research, which emphasizes the importance of your allocation to stocks or bonds.

Robo-advisor vs. financial advisor costs

Depending on your robo advisor, you may also be able to further specify investments by social values or religious views. How Taxes Work for a Robo Advisor Account As with any form of investment, your tax liability for robo-managed assets depends on the type of account in how to make a robot advisor yourself you hold the assets.

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If you hold your assets in an IRA, Roth IRA, or another type of tax-deferred retirement account, you pay no taxes until you withdraw funds. Withdrawals from a Roth IRA account may be tax-free, depending on the circumstances of the withdrawal.

If you own investments in a taxable account, then you will need to report those on your tax return and pay taxes on earnings, similar to investing in a brokerage account.

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You'll receive a form each year that reports the interest, dividends, and capital gains on the investments. If sales do occur, you will face capital gains tax liability. Robo Advisor Fees Robo advisor fees may be structured as a fixed monthly fee or as a percentage of assets.

Percentage fees range from roughly 0. It's important to remember that these fees are separate from any fees associated with the investments.

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For example, mutual funds and exchange-traded funds within your robo advisor account will likely come with their own expense ratios. This type of fee is taken out of the assets of the fund before returns are distributed to investors. Some of these online portfolio solutions offer a free trial period so you can see how the service works before you are charged.

Pros and Cons of Robo Advisors Pros.