Some 4 million adults in the U.S. will entrust their investment dollars to a robo-advisor in 2022 instead of a human. 

But how do robo-advisor returns stack up? And what do robo-advisors charge? What do investors get for those fees? To answer these questions, it’s important to understand what these popular digital investment platforms do and don’t do.

What is the average robo-advisor return?

Most robo-advisors have a passive approach and invest in low-cost index ETFs and mutual funds. This means the results should closely match the performances of the underlying indexes—but not beat them. 

Even so, robo-advisors that use the same strategy and asset allocations can have markedly different returns. For instance, the total return for portfolios composed of 60% stocks and 40% bonds showed a wide variation in a backend benchmarking analysis of 44 robo-advisors. Returns ranged from a low of 13.37% to a high of 25.17%, after fees were subtracted, in the 12 months ended Sept. 30, 2021.

During the same period, the Standard & Poor’s 500 Index, which tracks 500 of the largest companies by market value, delivered a 29.4% total return.

How to understand robo-advisor fees

A robo-advisor is a service—almost always accessed through a website—that relies on computers and algorithms to invest and manage money for consumers. They vary in size, scope, and services, but they all provide basic money management functions and develop investment portfolios. Robo-advisor fees generally cover basic account oversight and maintenance, although each robo-advisor has its own fee structure and menu of services.

Because a computer is doing most of the work rather than a human, the costs tend to be lower than that of a human advisor—in the range of 0.25% to 0.50% annually of the assets in the investor’s account. In contrast, a human investment advisor will usually charge a fee of 1% or more of the assets under their management per year. “They are going to cost less than your local financial advisor, who is a human you can pick up the phone and call or send an email and get a personalized response,” says Titan strategist Myles Udland.

Some robo-advisors charge much lower management fees or no fees at all. Others offer a sliding scale that’s pegged to the value of the portfolio. Still others may charge a monthly or annual subscription fee, an initial set-up fee, or charges for specific services rather than a percentage-based management fee. 

What services do robo-advisors offer?

Beyond investing a customer’s funds, robo-advisors generally offer three main services for the management fee. They include:

• Diversification

  . The robo-advisor’s algorithms yield a diversified portfolio that aligns with the investor’s requirements. The investments generally feature a variety of low-cost, exchange-traded funds (ETFs) and mutual funds that track indexes in a passive investing approach. The selections are likely to include U.S. and international stocks, bonds, and real estate investment trusts. Computers design a portfolio that blends a mix of stocks and bonds tailored to the client’s goals and tolerance for risk. 

• Auto-rebalancing

  . Of course, the value of the assets in a portfolio can change, sometimes dramatically. When that happens, the algorithms that power a robo-advisor buy and sell holdings, rebalancing the investment account to keep the asset allocation in line with the client’s original guidance.

• Tax-loss harvesting

  . Many robo-advisors provide a strategy known as tax-loss harvesting. This procedure minimizes the impact that capital gains from profitable investments have on a client’s tax liability. Algorithms first identify and sell assets that have unrealized losses. Then they replace the tax-harvested item with a similar security to maintain the investor’s specified allocation. Come tax time, the losses can offset taxable capital gains and reduce overall tax payments.

How do robo-advisors make money?

Management fees are the main money-makers for robo-advisors. Every client will pay this fee, which is usually charged monthly or quarterly and deducted from the customer’s account. 

Robo-advisors vary in how much access—if any—a client will get to a human professional for help with complex situations that call for individualized advice. Individuals who need support beyond a robo-advisor’s basic offerings can pay for premium services. Customers pay for these services in various ways.

Some robo-advisors boost the percentage of their management fee to account for the additional help. The percentage a client pays rises with the access they get to a dedicated investment advisor, certified financial planner, or other personalized help or extra service.

Rather than increasing the management fee, a robo-advisor may levy a monthly or annual charge for access to a human advisor or other premium service. In this case, the client would pay both the management fee plus the additional dollar amount. A robo-advisor also might offer a la carte financial planning sessions for a set price, again in addition to the management fee.

Investors who feel more secure with this type of hand-holding should make sure the robo-advisor they choose offers such premium services—and they know how much the extra support will cost.

Robo-advisors sometimes enjoy other revenue sources that may not be so obvious. These include:

• Interest on the cash in an investor’s portfolio.

  The cash earns interest, which can go to the robo-company, not the investor.

• Payment for order flow.

  Robo-advisors, like other money managers, can aggregate their trades and submit this block of activity to a trading platform that offers a rebate for sending business its way.

• Charges for withdrawals.

  These generally are a percentage of the transaction amount, including expedited deposits, funds transfers and other transactions. ‍

• Other services.

  Robo-advisors have also begun to branch out beyond their customary and premium offerings. Some companies sell financial products or services, including loans and tax preparation.

Pros & cons of robo-advisors

Robo-advisors have potential advantages and disadvantages for investors looking for help managing their money and building wealth.

Pros of robo-advisors

• Low fees

  . Robo-advisors almost always cost less than human advisors—even with additional premium services.

• Set it and forget it

  . Robo-advisors take the guesswork out of money management with algorithms set to an investor’s goals. Routine tasks like account rebalancing are generally included.

• Accessibility

  . Robo-advisors’ low account minimums—in some cases, $10 is enough to start—open the door to more investors.

• Goal-setting

  . A robo-advisor’s client questionnaire and online planning tools help would-be investors clarify their financial goals.

Cons of robo-advisors

• Limited human contact

  . Computers do the work. While human interaction is possible, it’s not the norm—and it comes at an additional cost.

• Less personalization

  . Robo-advisors offer investment strategies designed for a specific profile, not an individual investor. Customizing a portfolio and adding individual stocks is not usually possible. 

• Limited offerings

  . Robo-advisors generally don’t offer the full range of services available from a human financial advisor such as estate and tax planning.

• Market returns

  : Because robo-advisors take a passive approach to investing that seeks to match market returns, they may not appeal to active investors who hope to beat market averages.  

The bottom line

Robo-advisors are an increasingly popular alternative to traditional human financial advisors. Their fees are generally lower than those charged by human investment advisors because of their reliance on computers and algorithms to make the investment decisions. 

Each robo-advisor varies in the services it offers and the fees it charges. Most use strategies that take a low-cost passive approach, investing in ETFs and mutual funds that track indexes in an attempt to match average market returns. But some robo-advisors have started offering personalized and premium services that come at additional cost.