Robo Advisors vs. Index Funds (2024)

FAQs

Robo Advisors vs. Index Funds? ›

Index funds are low-cost mutual funds or exchange-traded funds (ETFs) that passively track a benchmark index, sector, or asset class. Robo-advisors are affordable automated investment platforms that often construct well-diversified portfolios based on a mix of index ETFs.

Index funds give the investor a wide range of choices and save the management fee associated with a robo-advisor. People who are less confident about investing or those who want planning and other advice will find a robo-advisor that offers online support and long-term investment management.

Do robo-advisors outperform the S&P 500? Robo-advisors can outperform the S&P 500 or they can underperform it. It depends on the timing and what they have you invested in. Many robo-advisors will put a percentage of your portfolio in an index fund or a variety of funds intended to track the S&P 500.

Exchange-traded funds (ETFs) and index funds are similar in many ways but ETFs are considered to be more convenient to enter or exit. They can be traded more easily than index funds and traditional mutual funds, similar to how common stocks are traded on a stock exchange.

Digital Advisor Use Dropped in 2022

High-net-worth investors exited robo-advisor arrangements at the highest rates.

Disadvantages include the lack of downside protection, no choice in index composition, and it cannot beat the market (by definition).

Learn how fees, enhanced features, and investment options can also be key considerations. Five-year returns from most robo-advisors range from 2%–5% per year. * And the performance of these automated investment services can vary based on asset allocation, market conditions, and other factors.

A Lack of Real Diversification

If you were to look at the portfolios offered by any of the major robo-advisors, you'd see that they consist mostly of just two asset classes: Stocks and bonds.

The generic cons of Robo Advisors are that they don't offer many options for investor flexibility. They tend to not follow traditional advisory services, since there is a lack of human interaction.

“In my view, for most people, the best thing to do is own the S&P 500 index fund,” Buffett said at Berkshire's 2020 annual meeting. Buffett's thinking here is straightforward. Most non-professional investors (and even many professional stock-pickers) have very little chance of outperforming the market.

Is there a downside to index funds? ›

While indexes may be low cost and diversified, they prevent seizing opportunities elsewhere. Moreover, indexes do not provide protection from market corrections and crashes when an investor has a lot of exposure to stock index funds.

Because the goal of index funds is to mirror the same holdings of whatever index they track, they are naturally diversified and thus hold a lower risk than individual stock holdings. Market indexes tend to have a good track record, too.

ETFs and index mutual funds tend to be generally more tax efficient than actively managed funds. And, in general, ETFs tend to be more tax efficient than index mutual funds. You want niche exposure. Specific ETFs focused on particular industries or commodities can give you exposure to market niches.

Limited Flexibility. If you want to sell call options on an existing portfolio or buy individual stocks, most robo-advisors won't be able to help you. There are sound investment strategies that go beyond an investing algorithm.

It ultimately comes down to your personal preferences, investment goals, and lifestyle. For example, the best robo-advisors offer specialized services like tax-loss harvesting, which may be important for some investors. Indeed, the choice between a robo-advisor and self-directed investing is personal.

2 Cybersecurity threats. Another risk of using robo-advisors is that they may be vulnerable to cyberattacks that compromise your data and assets. Robo-advisors store and process large amounts of sensitive information, such as your identity, bank accounts, portfolio holdings, and transactions.

For some, the simplicity, accessibility, and lower costs make them a very appealing choice. However, for those desiring more personalized service and sophisticated investment strategies, a human financial advisor may be worth the additional cost.

While a robo-advisor can be efficient in managing your investing decisions, a human advisor may be best for more complex decisions like helping you choose the right student loan repayment plan or comparing compensation packages for a new job. Cost: If cost is a factor, robo-advisors typically win out here.

Wealthfront is a popular robo-advisor that uses algorithms to create and manage investment portfolios for clients. They offer a range of investment options, including stocks, bonds, and real estate. According to their website, their average annualized return for a diversified portfolio is 7.5%.

Robo-advisors typically have lower fees than traditional wealth managers. The cost to use a robo-advisor generally ranges from 0.25% to 0.50% of your portfolio compared to 0.5% to 1.5% for traditional advisors. Low minimums.