Robo-advisors provide automated, algorithm-driven financial planning and investment services without human supervision and help investors optimize their portfolios.
Exchange-traded funds (ETFs) are chosen by investors who determine the types of assets that will best help them reach their investment goals. The variety of available ETFs gives individuals access to targeted areas of the market but without the guidance of an advisor.
Key Takeaways
- Investing in exchange-traded funds (ETFs) gives investors flexibility and control to target specific sectors.
- 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.
What Is an ETF?
An exchange-traded fund (ETF) is a pooled investment of a basket of financial instruments. Unlike mutual funds, ETFs trade on exchanges like individual stocks, fluctuating in value throughout the trading day. ETFs provide a cost-effective and liquid vehicle to invest in multiple underlying assets targeting a specific sector or sectors.
When ETFs burst onto the scene in the 1990s, they provided a low-cost, easy way to invest in a group of securities or a market index. Investors have continued to pour funds into ETFs with growth expected to double from 2022 to 2027.
Investors can find ETFs focusing on stocks, commodities, and bonds or choose a fund that tracks a broad market index like the iShares Russell 3000 Fund (IWV), which tracks the Russell 3000. Investors can choose a specific sector like energy and invest through an ETF like the Energy Select Sector SPDR Fund (XLE).
In January 2024, theSecurities and Exchange Commission (SEC)approved eleven newspot bitcoin ETFslisted on the NYSE Arca, Cboe BZX, and Nasdaq exchanges. In May 2024, it effectively approved ether ETFs to trade on the same exchanges.
What Is a Robo-Advisor?
As its name implies, a robo-advisor is an automated alternative to traditional financial advice. Since launched in 2008, the digital platforms are designed to help investors build customized portfolios based on their financial goals.
A robo-advisor uses algorithms to deliver personalized investment planning services. Investors typically complete an online survey that assesses financial goals, time horizons, and risk tolerance. Then, the robo-advisor uses proprietary data to construct a portfolio to meet that investor’s needs.
Working with a robo-advisor allows investors to access professional investment management services at a lower price than a human advisor. Some of the best robo-advisors can even automate other aspects of an individual's strategy like tax-loss harvesting, or strategically selling assets at a loss to offset taxable gains on other investments.
Key Differences
The main distinction between an ETF and a robo-advisor revolves around the level of guidance provided to the investor. ETFs allow investors to focus their portfolios on certain sectors, but individuals must decide which funds to buy. A robo-advisor allows individuals to automate investment decisions by recommending a portfolio customized to help meet investment goals.
Most ETFs are passively managed, designed to replicate the performance of an underlying index. The ETFs that do operate with active management strategies typically have a higher expense ratio—the percentage that investors pay in fees for administrative and operating expenses.
Robo-advisors typically use ETFs to construct a portfolio that aligns with their client’s goals and preferences. In other words, investors who choose a robo-advisory service will likely buy shares of ETFs to access the segments of the market recommended by a virtual advisor.
ETF: Advantages and Disadvantages
Pros
Easy to trade
Very flexible
Low fees
Huge array of ETFs available
Cons
Can require a lot of legwork
Need to monitor portfolio
Expenses and transaction costs may eat into profits
ETFs provide an easy-to-trade and low-fee vehicle for investing in a basket of securities. The huge array of ETFs available—tracking everything from broad swaths of the market to specific industries and investment themes—opens the door to a seemingly infinite realm of possibilities.
However, investing in ETFs can require a lot of legwork and research. While ETF fees tend to be reasonable, paying for a fund’s administrative and operating expenses can eat into profits. Many brokerage platforms offer commission-free ETF trading.
Robo-Advisor: Advantages and Disadvantages
Pros
Low-cost alternative to human financial advisors
Personalized portfolios
Offer strategies like tax-loss harvesting and rebalancing
Cons
Lack human touch
Limited set of investments and strategies available
May not be able to see the whole picture
Robo-advisors offer a significant cost advantage compared with traditional, human financial advisors. Most robo-advisors adopt Modern Portfolio Theory (MPT), aiming to maximize returns while sticking within the investor’s threshold for risk, and algorithmically developing a strategy tailored to an individual’s needs.
Some robo-advisors can help investors adjust their portfolios via rebalancing and tax-loss harvesting. However, they lack the human touch and cannot see the full picture when analyzing an individual’s financial situation.
Are Robo-Advisors Better than Index Funds?
Robo-advisors give digital guidance on portfolio investment, while index funds provide investors exposure to the underlying components of a market index. Robo-advisors may be more useful if an individual is looking for support in developing a strategy. Still, index funds can be an essential tool for the investor who has already decided which part of the market to target.
What Is an All-In-One ETF?
An all-in-one ETF is a type of investment that gives exposure to a broad range of assets within a single fund. For instance, a conservative all-in-one ETF may allocate 60% of its portfolio to bond ETFs and 40% to stock ETFs, providing an entire portfolio for conservative investors within a single investment.
What Type of Investor Chooses a Robo-Advisor?
Robo-advisors may be a good option for investors with smaller amounts of money available to invest because of their reasonable fees and low minimum deposit requirements. Robo-advisors are useful for beginners because they provide an automated framework that removes the guesswork from investment decisions.
What Type of Investor Chooses ETFs?
ETFs allow investors to access broad or targeted areas of the market with high liquidity, and low costs. Despite these advantages, ETFs are best suited for investors who know how they work and understand the risks involved. Since do-it-yourself ETF investors receive neither human nor automated advice, independently building a successful portfolio may require some knowledge and experience.
The Bottom Line
ETFs and robo-advisors are tools for investing. ETFs provide low-cost, diversified exposure to a collection of assets, typically designed to replicate the performance of an underlying market index. Robo-advisors are digital platforms that can help investors tailor a portfolio that aligns with their goals and at a lower cost than working with a human advisor.
