How And Where Robo Advisors Invest Your Money

In an early January Juice, we covered the basics of robo advisors. That is, automated investing platforms that use algorithms to place investors in a portfolio of (usually) ETFs based on their time horizon, risk aversion and goals: 

Robo advisory, or automated investing, isn’t just some cool high-tech fad in the age of AI. The Juice thinks it’s here to stay. And one reason is because of the angst, particularly among Gen Z, we have discussed this week. 

Increasingly, people feel like the money-related parts of life are impossible. We empathize. But the answer isn’t to give up, especially on long-term planning. Especially when you have so many free (like The Juice!) and low-cost tools at your disposal to put investing and the rest of your personal finance in good hands and on autopilot.

Exactly. 

Which is one reason why after that installment, some Juice readers reached out asking for additional details on how robo advisory works. To provide more color let’s take the process step by step. 

Account Creation

This is where the rubber meets the road. As we noted in that aforementioned Juice:

For the big boys, we’d go with Schwab, particularly because we love their onboarding process. It’s thorough and extensive. And, unlike many other robo advisors, Schwab’s automated investing service gives you a clear idea of where you’ll be invested before you sign up.

So, here’s some advice you won’t find in every other robo-advisor article. Even if you’re not going to go with Schwab, go through their process. If you’re unfamiliar with automated investing, Schwab’s detailed questions and subsequent allocation example will go a long way to showing you how it works. Without any commitment. 

While Schwab provides the best example, all robo advisors ask you about your goals (e.g., retirement, general saving, short-term goal). Then, they quiz you about risk with questions like:

• What would you do if the stock market dropped by X amount? 
• Would you sell everything, sell some, do nothing, buy more?
• How much are you willing to risk in exchange for a potential reward as high as X?

So, if you say you’re investing for retirement, you’d buy more on a market correction and you’re willing to risk losing 10% of your portfolio’s value to see 20% worth of upside, expect the robo-advisor’s algorithm to spit out a portfolio allocation heavy on stocks (probably between 80% and 90%) and low on bonds and cash. Give more conservative responses, get a more conservative portfolio a bit lighter on stocks and heavier on bonds. 

From here, account creation is hardly different than opening a standard brokerage account. You might select between a taxable account or IRA, then you’ll be asked to select a funding method. Here again, Schwab doesn’t ask for personal information until the very end of the onboarding process, whereas most other robo-advisor platforms want it sooner, if not right away. 

Investment Types

Pretty much across the board, you can expect your robo advisor to put you in a basket of ETFs. In many cases, robo advisors use ETFs from large fund families with low expense ratios. So don’t be surprised if one or more of the Vanguard ETFs investors search for most (see them above in today’s Trackstar top five) wind up in your account. Other popular fund families used by robo advisors include Schwab and iShares. 

In some cases, you’ll be placed in proprietary ETFs. While this usually isn’t a problem with, say, the Vanguard, Schwab or Fidelity robo advisors, it can be with firms such as Betterment and SoFi. These FinTechs, particularly SoFi, have their own ETFs that, sometimes, carry high expense ratios. As we recently noted, avoid these and other high-expense ratio ETFs at all costs. 

Automatic Rebalancing

One of the problems DIY investors run into is having their target allocations thrown off as their holdings increase and decrease in value or as time passes. Of course, this assumes the DIY investor is even starting with a nicely diversified portfolio. Robo advisors make sure you’re appropriately allocated, then they keep you where you need to be. 

They do this by having the algorithm regularly (usually daily) keep tabs on your portfolio. As your allocation gets out of whack, your robo advisor will make adjustments to bring it back in line. This often means your robo advisor will buy and sell investments without asking you first. So, ensure you’re good with giving up this control before you commit. 

Tax-Loss Harvesting

In a December Juice, we defined and detailed — with a specific example — tax-loss harvesting:

While tax loss harvesting doesn’t always make sense, it can when you’re holding stocks you think have become a lost cause …

You can always hang onto your winners and claim your capital losses, up to $3,000, to offset your taxable income. But, if you’d like to take profits, you can ease the brunt of your tax bill, by selling losers and doing a little year-end tax loss harvesting.

Many robo advisors offer this feature. Some include it for free. Others charge you extra for it. Here again, you’ll relinquish some control if you opt for your robo advisor to execute tax-loss harvesting on your behalf. 

The Bottom Line: We like to say that ETFs take the guesswork out of investing. Robo advisors go a step further. They not only put you into ETFs, they select particular funds that make the most sense for you, based on your specific situation. 

If you need a push to start investing and don’t have time to maintain your portfolio, a robo advisor can make sense. They could help tech-savvy Gen Z get a headstart on their retirement savings.

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