Do robo-advisors only invest in ETFs?
Robo-Advisors Choose Your Investments
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 S&P 500.
While the two are different, robo-advisors and ETFs can intersect because robo-advisors often build clients' portfolios with ETFs. It's important to understand the roles ETFs and robo-advisors play and what they can—and can't—offer investors.
ETFs make a great pick for many investors who are starting out as well as for those who simply don't want to do all the legwork required to own individual stocks. Though it's possible to find the big winners among individual stocks, you have strong odds of doing well consistently with ETFs.
Limited Flexibility. If you want to sell call options on an existing portfolio or buy individual stocks, most robo-advisors won't be able to help you. There are sound investment strategies that go beyond an investing algorithm.
Index funds are low-cost mutual funds or exchange-traded funds (ETFs) that passively track a benchmark index, sector, or asset class. Robo-advisors are affordable automated investment platforms that often construct well-diversified portfolios based on a mix of index ETFs.
The generic cons of Robo Advisors are that they don't offer many options for investor flexibility. They tend to not follow traditional advisory services, since there is a lack of human interaction.
Do robo-advisors outperform the S&P 500? Robo-advisors can outperform the S&P 500 or they can underperform it. It depends on the timing and what they have you invested in. Many robo-advisors will put a percentage of your portfolio in an index fund or a variety of funds intended to track the S&P 500.
Robo-advisor performance is one way to understand the value of digital advice. Learn how fees, enhanced features, and investment options can also be key considerations. Five-year returns from most robo-advisors range from 2%–5% per year.
Funds' expense ratios: The robo-advisor will invest your money in various funds that also charge fees based on your assets. The fees can vary widely, but across a portfolio they typically range from 0.05 percent to 0.25 percent, costing $5 to $25 annually for every $10,000 invested, though some funds may cost more.
Why I don t invest in ETFs?
Market risk
The single biggest risk in ETFs is market risk. Like a mutual fund or a closed-end fund, ETFs are only an investment vehicle—a wrapper for their underlying investment. So if you buy an S&P 500 ETF and the S&P 500 goes down 50%, nothing about how cheap, tax efficient, or transparent an ETF is will help you.
Low Liquidity
If an ETF is thinly traded, there can be problems getting out of the investment, depending on the size of your position relative to the average trading volume. The biggest sign of an illiquid investment is large spreads between the bid and the ask.
Lack of Global Diversification
The S&P 500 is all US-domiciled companies that over the last ~40 years have accounted for ~50% of all global stocks. By just owning the S&P 500 you miss out on almost half of the global opportunity set which is another ~10,000 public companies.
Digital Advisor Use Dropped in 2022
High-net-worth investors exited robo-advisor arrangements at the highest rates.
Pros | Cons |
---|---|
Often less expensive than working with a professional financial advisor | More costly than doing it yourself |
Easy to start and may have a low account minimum | Could take a narrow view of your investments or financial situation |
Includes ongoing management | Limited personalization |
Robo-advisors lack the ability to do complex financial planning that brings together your estate, tax, and retirement goals. They also cannot take into account your insurance, general budgeting, and savings needs.
Warren Buffett made his fortune by investing in individual companies with great long-term advantages. But his top recommendation for anyone is to buy a simple index fund. Buffett's recommendation underscores the importance of diversification.
This will vary significantly depending on the risk profile of the portfolio, broader market conditions, and the specific robo-advisor used. Some robo-advisor portfolios may outperform the S&P 500 in certain years or under specific conditions, while in others, they underperform.
Markets can be unpredictable, and no form of investing is immune to potential losses. Robo-advisors, like human advisors, cannot guarantee profits or protect entirely against losses, especially during market downturns—even with well-diversified portfolios.
But according to the Robo Report, the five-year returns (2017 to 2022) from most robo-advisors range from 2% to 5% per year. And Wealthfront, one of the best robo-advisors available, also states that customers can expect about a 4% to 6% return per year, depending on their risk tolerance.
Why would you use a robo-advisor instead of a financial advisor?
For core investing and planning advice, a robo-advisor is a great solution because it automates much of the work that a human advisor does. And it charges less for doing so – potential savings for you. Plus, the ease of starting and managing the account can't be overstated.
Suppose you're starting from scratch and have no savings. You'd need to invest around $13,000 per month to save a million dollars in five years, assuming a 7% annual rate of return and 3% inflation rate. For a rate of return of 5%, you'd need to save around $14,700 per month.
“In my view, for most people, the best thing to do is own the S&P 500 index fund,” Buffett said at Berkshire's 2020 annual meeting. Buffett's thinking here is straightforward. Most non-professional investors (and even many professional stock-pickers) have very little chance of outperforming the market.
Robo-advisors help automate the decision-making, recommending a portfolio that aligns with an investor's goals and preferences. Robo-advisors may carry higher fees than ETFs, but their costs usually remain below those of a traditional human advisor.
Company | Account Minimum | Fees |
---|---|---|
SoFi Automated Investing Best for Low Costs | $1 | $0 |
M1 Finance Best for Sophisticated Investors | $100 ($500 minimum for retirement accounts) | 0%, $36/year for M1 Plus |
Acorns Best for Those Who Struggle to Save | $0 | $3-$5/month |