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Financial management

How a robo-advisor works and benefits investors

Robo-advisors help to simplify financial management. Read our overview to learn about how they work, benefits, and who should consider one.
8 minute read
  •  
January 26, 2023
Financial management
Robo-advisors
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Article
Managing portfolios

Financial advisors help investors make smart decisions about their investments, set goals, and reach those goals in an ever-changing environment. But with the progression of technology, algorithms, and artificial intelligence, financial institutions across the board are offering an increasingly popular alternative to the traditional personal advisor: the robo-advisor.

But how do they work? Read our overview about how robo-advisors can help investors with financial management and why a robo-advisor might be a good fit for your investing needs.

What's a robo-advisor?

A robo-advisor is an online platform that manages your investments automatically while helping you reach your financial goals. It's financial advice that comes from an algorithm—in other words, a computer program—instead of a person.

This image is an example only.

How does a robo-advisor manage investments?

A robo-advisor combines your information with its programming technology to create your personalized investing strategy. When a robo-advisor works 24/7 to manage your portfolio, it automatically adjusts your investments to current market conditions. It can review and rebalance your allocation of assets (stocks, bonds, and cash) in response to your specific investment goals and timelines.

You can add a robo-advisor to your existing portfolio or open a new account with the required minimum investment. When you sign up for a robo-advisor, the system may walk you through an initial setup that asks you for basic investing information that could include:

Goals

Are you saving for retirement, a car, a house, a wedding, or another long-term financial decision? A robo-advisor will typically allow you to set multiple goals if you have more than one.

Risk tolerance

How much risk are you willing to take with your investments? Some robo-advisors can help you assess your comfort level with risk, which often relates to where you are in your investing journey. Other robo-advisors may ask you directly to provide the risk tolerance you want without a guided assessment.

If you're investing as a young professional, you're able to take on more risk because you have a longer runway to manage the ups and downs of volatile markets. If you're closer to retirement, a lower-risk investment strategy may be a better fit. Knowing this will help the robo-advisor set your asset allocation—the mix of stocks, bonds, and cash that's appropriate for you.

Length of time for each goal

How long do you want to invest for each goal? This requires some level of estimated projection, but ultimately, determining these timelines will help the robo-advisor track your progress and keep you on target while balancing multiple short- and long-term goals.

How a robo-advisor helps simplify investing

There are multiple ways a robo-advisor can help with simplifying the complex world of investing. First, it's always on—meaning it requires little supervision or input after the initial intake of your goals and timelines. The 24/7 nature of a robo-advisor means that your portfolio can respond quickly to new goals and market changes without human intervention. Additional benefits of using a robo-advisor may include:

Personalized investing strategy

Achieving goals is easier when you have action steps within a defined strategy. When you use a robo-advisor, you'll receive ongoing feedback about whether you're on track to meet your goals, which can help you stay focused on the bigger picture. If you want to check your progress, you can log in to your account anytime.

Automated investing

Making informed choices about how to invest your money requires time, energy, and a desire to dive deep into the workings of the investing world. When you have multiple priorities to juggle—like eldercare, children, family issues, a job, and a household—scheduling time to work on your portfolio may fall to the bottom of your to-do list. A robo-advisor automatically balances your investments to help you reach the goals that matter most to you: retirement, a new house, your next car, etc.

Holistic financial perspective

Some robo-advisors allow you to add external accounts for a better understanding of your complete investing journey. Having a singular view of your progress is not only motivating, but it also helps you make more informed decisions about how to grow your investments. An added bonus: You'll only need to remember one password, which is a small luxury in this technology-driven world we live in.

Who should consider a robo-advisor for financial management?

Not everyone needs or wants to be an investing expert. And that's okay. A robo-advisor is a great option for those who don't want the stress of keeping up with the markets or managing their own portfolios. You can simply set up your account and check in as often or as little as you want. And you get the peace of mind that comes from knowing your money is working hard for you without the time and effort it takes to do everything yourself.

A robo-advisor is also a great tool for those who want guidance at a lower cost. Traditional financial advisors usually cost more, and if you're just starting out, you may not be willing or able to factor that cost in your budget.

What you should look for in a robo-advisor

Not every robo-advisor is the same, and you should evaluate each option according to your goals, your investing preferences, and the account features that are important to you.

As mentioned earlier, robo-advisors are run by programs. The program coding, which serves as the foundation for the behavior and responses of a robo-advisor, will directly reflect the investment philosophy of the platform's provider.

So you're not just assessing the tool itself. You're also evaluating the company behind it, which leads to additional questions: Do you trust the company and its investing philosophy? How does the company serve its clients, and how is that reflected in its robo-advisor?

Cost is also an important factor to consider. Robo-advisors have advisory fees, so it's best to choose one that's low-cost and doesn't charge extra fees. Be sure to also look at the investment minimum, which is how much the robo-advisor requires to service your portfolio. This can range from a few hundred dollars to thousands or even tens of thousands of dollars.

Robo-advisors: The low-cost advice alternative

Robo-advisors can offer simplified investing for investors who want professional guidance without the cost of a traditional advisor. Because every robo-advisor is different, it's important to pick one that you trust and that makes sense for your goals. Remember, you don't need to be an expert to start (or continue) investing. But if you're looking to delegate your portfolio management, a robo-advisor may be a good fit for you.

Vanguard Digital Advisor®

If you think automated investing is right for you, consider Digital Advisor, Vanguard's robo-advisor.

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All investing is subject to risk, including the possible loss of the money you invest.

There is no guarantee that any particular asset allocation or mix of funds will meet your investment objectives or provide you with a given level of income.

Vanguard Digital Advisor is provided by Vanguard Advisers, Inc. ("VAI"), a federally registered investment advisor. VAI is a subsidiary of VGI and an affiliate of VMC. Neither VAI nor its affiliates guarantee profits or protection from losses.