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A robo-advisor can invest on your behalf — here's how they work

If you are ready to put your investments on autopilot, a robo-advisor could be for you.

Select’s editorial team works independently to review financial products and write articles we think our readers will find useful. We earn a commission from affiliate partners on many offers, but not all offers on Select are from affiliate partners.

It's a typical situation: You know you need to invest money in order to truly grow your wealth (and save for retirement), but you don't know the first thing about how investing in the market actually works.

The world of stocks and bonds is certainly a daunting one. Enter: robo-advisors.

If you don't know much about investing, a robo-advisor can be a good tool to help you begin. You've likely heard the term "robo-advisor" before. Betterment and Wealthfront, the pioneers in robo-advising, have been around since their 2008 inception during the financial crisis. Automated investing was a new, straightforward and low-cost way to invest that didn't rely on a human managing your portfolio.

Using computer algorithms and data, robo-advisors are essentially software platforms that invest on your behalf. They charge much lower advisory fees than a traditional financial advisor and setting up an account takes only minutes. From then on, you may never have to raise a finger since robo-advisors automatically rebalance your portfolio from time to time based on your risk tolerance, market conditions and other factors.

Here's how robo-advisors work

A robo-advisor's job is to create an investment portfolio for you and then manage it along the way so you don't have to.

Step 1: Open an account, answer questions, deposit cash to invest

Once you decide to open an account with a robo-advisor, you'll start by creating a login. You'll usually then be asked to complete a brief questionnaire. Questions are likely to include your age, your investment goals, your investment time horizon and your overall risk tolerance, i.e. how much risk you are willing to take.

In the setup stage, you'll also connect your new investment account to a bank account to fund it. While you'll make an upfront deposit to get started (different robo-advisors have different minimum deposits), the idea is that you keep contributing to your account so that you have more money growing over time.

A robo-advisor with no minimum deposit, balance requirements

Those who choose active or automated investing through SoFi Invest® have no account minimums. You can also participate in IPOs at no minimum.

Step 2: The robo-advisor gets to work

Completing this set of questions helps the robo-advisor determine where to allocate your cash. Many robo-advisors use a popular strategy called modern portfolio theory, or MPT, that follows funds like the S&P 500 and prioritizes diversification to minimize risk. Robo-advisors thus rely on low-cost mutual funds or index fund exchange-traded funds (ETFs) that spread your investments across different assets.

Step 3: The robo-advisor may customize to your investment goals

Beyond just mutual funds and ETFs, however, the robo-advisor uses your investment goals ultimately to help decide your asset allocation.

Your investment portfolio to save for a future home in the short term will most likely look different than your portfolio to save for retirement in the long term. In fact, more and more robo-advisors offer individual retirement accounts (IRAs) for retirement purposes.

A robo-advisor with options

Wealthfront offers an array of investment vehicles, including a taxable brokerage account but also traditional, Roth, SEP and/or a Rollover IRA. It also stands out for letting investors save for their kids' college years early on through a 529 account.

For those who want to be a bit more hands-on during this process, you may be able to choose certain themed portfolios, such as a socially responsible portfolio. More experienced investors, with perhaps more cash, typically have other customized investment options. For instance, Wealthfront allows you to allocate a portion of your portfolio to cryptocurrency or sector-specific ETFs like tech or health care.

Step 4: Robo-advisors will keep your portfolio in check automatically

As market conditions change, or as you invest more money, the robo-advisor's software will automatically adjust your portfolio to best align with reaching your goals. This periodic buying and selling is better known as "rebalancing."

Though robo-advisors are based on the premise of no human supervision, some offer access to real financial advisors should you want one on your investing journey.

A robo-advisor that gives you human access

Those who value talking to a real-life financial advisor should consider a robo-advisor like Betterment. Its premium plan allows users to get unlimited access to a financial advisor. Otherwise, one-time advisor consultation fees range from $199 to $299.

Bottom line

If you are ready to put your investments on autopilot, a robo-advisor could be a good choice for you. You don't need much money, time or knowledge to get started. While we mention some of the top ones in this article, know that many online brokerage firms have their own robo-advisor component that allows for automated investing as an option to investors.

And, you can trust most robo-advisors. Just like a human financial advisor, legitimate robo-advisors are registered with the U.S. Securities and Exchange Commission (SEC) and thus follow the same laws and regulations that a traditional human broker would. Most robo-advisors are also members of the Financial Industry Regulatory Authority (FINRA). You can check a robo-advisor's registration and licensing through the free BrokerCheck tool.

Editorial Note: Opinions, analyses, reviews or recommendations expressed in this article are those of the Select editorial staff’s alone, and have not been reviewed, approved or otherwise endorsed by any third party.
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