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Robo-Advisors vs. ETFs: What Are the Main Differences?

March 17, 2022
6
min

Robo-advisors are digital services that take much of the guesswork out of building and managing a portfolio. ETFs bundle stocks, bonds, commodities, and other types of investments into a single security that trades on an exchange like a stock does.

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Since the first robo-advisor in the U.S. was launched in 2008, their ranks have expanded dramatically. U.S. robo-advisor users are projected to top 16 million by 2025. Assets under management are forecast to increase by about 16% a year from 2022 to 2025 to just over $1.9 trillion in the U.S. alone.

ETFs have been around longer than robo-advisors but have enjoyed a similarly meteoric rise. Introduced in 1990, ETFs were developed to give investors access to various indexes and baskets of assets rolled into a single, low-cost, security that’s usually passively managed. Investors had poured $10 trillion into ETFs globally as of November 2021, 65% focused in North America. 

People often mention robo-advisors and exchange-traded funds (ETFs) in the same conversation when weighing investing approaches. 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. 

What are robo-advisors?

Robo-advisors are digital services that take much of the guesswork out of building and managing a portfolio. Algorithms pick the investments that best suit a client’s goals, time frame, and other self-determined objectives. Computers monitor the portfolio and automatically keep it in line with the investor’s specifications. Robo-advisors also may help a client manage their tax obligations in a process known as tax-loss harvesting—selling securities with capital losses that can be used to offset gains in other securities. 

Robo-advisors are growing in popularity, especially with individuals who are comfortable trusting a computer, rather than a person, with their financial fortunes. They tend to appeal to long-term investors and aren’t designed to facilitate active investing.

Robo-advisor fees average about 0.25% to 0.5% of the assets in a client’s account and are generally lower than a human advisor charges—but they are higher than operating fees for many ETFs (buying an ETF may also require a brokerage commission). Although robo-advisors usually offer online investing advice, they provide little direct contact with a person. Some do, however, make personal advisors available—usually for an extra fee. Some robo-advisors are branching out beyond money management into financial services such as loans and tax services.

What are ETFs?

ETFs bundle stocks, bonds, commodities, and other types of investments into a single security that trades on an exchange like a stock does. They are designed to track an index, industry, or other sector and deliver similar returns. Today’s ETFs track everything from broad market indexes, like the Standard & Poor’s 500 Index, to industry sectors, investing strategies, and thematic interests such as aging populations, cloud computing, and cryptocurrencies.

ETFs generally have lower fees than mutual funds, which operate on the same principles but often are actively managed. Only about 4% of ETFs in the U.S. are actively managed. They are generally more tax efficient than mutual funds, which generate capital gains when the manager buys and sells securities. ETFs generally track indexes, which requires less turnover. 

Most large money management and investment firms including Vanguard, Fidelity, and scores of others have created and market ETFs. Shareholders own a portion of an ETF but they don’t own the underlying asset. 

ETFs cover five main categories.

  • Industries: These ETFs provide exposure to stocks and other securities in specific industry sectors, such as healthcare and financial services.
  • Bonds: These funds track fixed-income securities including corporate, government, and international bonds.
  • Commodities: These ETFs cover individual commodities such as gold or a mixture of assets such as natural resources and agricultural products.
  • Currencies: These track the value of global currencies.
  • Inverse ETFs: These securities, also known as short or bear ETFs, are designed to perform inversely to the index they track.

Robo-advisors vs. ETFs: What are the main differences?

The differences between an ETF and a robo-advisor boil down to what each offers investors and the price the investor pays. 

  • Management. Humans have little role in managing robo-advisors or ETFs. But with robo-advisors, algorithms do the work that is performed by humans at traditional investment advisors, creating a customized portfolio based on an investor's goals and risk tolerance. ETF investors are on their own to determine their financial goals and create a portfolio that meets them. ETFs are not an investment platform or advisor.  
  • Fees. Fees for robor-advisors and ETFs tend to be lower than those charged by traditional investment advisors, mainly because they pursue passive investment strategies that require little human effort. But robo-advisors generally assess management fees on top of the fees assessed by the ETFs they buy. Robo-advisor fees range from about 0.25% to 0.5% of the investor’s portfolio value annually. Fees for ETFs can be as low as 0.02%, though brokers—online and traditional—sometimes charge commissions for buying or selling an ETF. 

Benefits and limitations of robo-advisors

Robo-advisors have pluses and minuses when compared to ETFs.

Potential benefits

  • Personalized: Robo-advisors survey clients to understand their goals and risk tolerance to build an appropriate portfolio.
  • Risk-return: Most robo-advisors subscribe to a passive investment strategy to capture the biggest returns with the least risk.
  • Advice: Robos provide investment advice via online sources and sometimes a real person.
  • Portfolio maintenance: Routine maintenance such as account rebalancing and tax-loss harvesting is often included at no additional cost.

Potential limitations

  • Cost: Robo-advisor costs often are higher than those for ETFs, although they generally cost less than a human advisor.
  • Limited choices: Robo-advisors usually rely on a stable of select securities, mainly ETFs that track specific indexes or sectors, limiting investor choices.
  • Performance: Returns can vary significantly among robo-advisors because of fees and investment choices.

Benefits and limitations of ETFs

Like robo-advisors, ETFs have pluses and minuses for investors.

Potential benefits

  • Cost: ETF investors don’t pay a management fee. And the expense ratio for the fund can be as low as 0.02% of the fund’s assets.
  • Accessibility: Investors can buy ETFs for themselves through a simple online broker account.
  • Variety: There are thousands of ETFs that track everything from the S&P 500 to video-game makers and the medical cannabis industry.
  • Control: The investor controls the ETFs they buy, giving them total flexibility.

Potential limitations

  • Investor effort: Investors must research, buy, monitor, and sell an ETF themselves unless they pay for professional guidance.
  • Fees: Some brokers offer free ETF trades, but some charge a commission. That’s on top of the expense ratio.
  • Liquidity: Non-mainstream ETFs may face liquidity problems that make them difficult to sell. Some may even shut down.
  • Returns: ETFs based on well-known stock and other indexes may not deliver the same returns because of fees and other issues.

The bottom line

Robo-advisors and ETFs provide two potential choices for a person shopping for an investment approach. 

Robo-advisors leave determining and executing a passive investment strategy to computers that provide advice and guidance online. The cost is lower than that of a human advisor, though some robo-advisors offer personalized service from a human, which can add to the cost.

ETFs are securities made up of other securities. They leave the investing know-how and portfolio maintenance to the individual. There is no hand-holding—human or otherwise. ETFs generally cost less than robo-advisors, but buying, selling and monitoring their performance requires more time, understanding, and perseverance.

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