You have money to invest and you already know a few broad index funds will do the job. Then you open the account, the fund list runs thousands of rows long, and it becomes homework you keep putting off. A robo-advisor sells you a way out: answer some questions, and software builds the portfolio and runs it. Here is what it does, what it charges, and where something cheaper does the same work.
What the Questionnaire Is Actually Doing
Every one of these services starts the same way. You fill in an online form: your goals, when you need the money, your income and other assets, and how you would feel about a sharp drop. The SEC's guidance says those answers may be the sole basis for the advice you get.
Your answers become a risk profile, and that profile maps to a fixed mix of funds. Saving for a house in three years puts you somewhere bond-heavy; saving for retirement in forty puts you somewhere stock-heavy. What arrives is a diversified set of low-cost index ETFs in fixed percentages, something like 60% US stocks, 25% international stocks and 15% bonds.
Notice what is missing. No one is picking winning companies. The service picks an allocation out of the same broad index funds covered elsewhere on this site, and then holds it.
The blind spot is built in. The form asks what it asks. Student loans at 9%, or an employer stock grant that ties half your net worth to one company, are invisible to it. Keeping your answers current is your job too, not the software's.
The Two Chores It Handles Automatically
Rebalancing is the first. Your target mix drifts as prices move. A strong year for stocks can push a 60% position up past 68%, which means you are carrying more risk than you chose. The service sells a slice of what grew and buys what lagged, on a schedule or whenever a holding drifts outside a set band. It is the step do-it-yourself investors skip most often.
Reinvesting is the second. Dividends arrive as cash, and cash left alone earns nothing. The service buys more shares with it, steering the money into whatever holding sits below target.
You Pay Two Fees, Not One
This is where cost comparisons go wrong. A robo-advisor quotes one number, an advisory fee charged yearly as a percentage of your balance. That is not the whole bill.
Underneath it sit the ETFs, and each charges its own expense ratio. Both come out of the same money. The SEC makes the point directly: total costs can be high even when the advisory fee looks small.
Here is illustrative arithmetic, with round numbers rather than any real service's price. Advisory fee 0.25%, underlying funds averaging 0.08%, all-in cost 0.33%. On a $10,000 balance that is $33 a year. On $100,000 it is $330 for the same work. The investment fees article on this site works through what a percentage point of annual cost does over a career.
Tax-Loss Harvesting, and Where It Stops Helping
The headline extra feature is tax-loss harvesting. When a fund you own falls below what you paid, the software sells it, books the loss, and buys a similar fund right away so you stay invested.
It offsets capital gains dollar for dollar. If your losses exceed your gains, you may deduct up to $3,000 of the excess against ordinary income each year, or $1,500 if you are married filing separately. Whatever is left carries forward into later years.
Three limits matter.
It only works in a taxable brokerage account. Inside an IRA or a 401(k), gains are not taxed year by year and losses are not deductible, so there is nothing to harvest.
The wash sale rule governs the replacement. Buy a substantially identical security within 30 days before or after the sale and the IRS disallows the loss. It gets added to the cost basis of the new shares instead. That is why the software buys a similar fund, not the identical one, and why buying that fund yourself elsewhere can undo the trade.
It defers tax rather than erasing it. Selling low resets your cost basis low, so a bigger taxable gain waits for you when you finally sell. What you gain is the use of that money in between.
When Your 401(k) Already Does the Job
Before paying an advisory fee, look at what a target-date fund in your 401(k) already does. It holds a diversified mix, shifts gradually from stocks toward bonds as the target year approaches, and rebalances itself. That is most of the robo-advisor's job description, as the choosing investments article explains.
The difference is the layering. A target-date fund charges one expense ratio and nothing on top. Those fees have fallen a long way, and the average target-date fund now sits well below what most robo-advisors charge once you add the advisory fee to the underlying funds. Index-based versions are cheaper again.
Most robo-advisors cannot manage your 401(k) anyway. So the common split is a target-date fund inside the workplace plan, and a decision about automation only for money outside it, which is the only money tax-loss harvesting can reach.
What the Algorithm Cannot Do
Robo-advisors register as investment advisers. That means they owe you the same fiduciary duty a human adviser does: a duty of care and a duty of loyalty. The legal standard is the same on both sides. What differs is scope.
A person answers the questions the form never asks. Whether to clear a 22% credit card balance before investing at all. What your employer's stock plan does to your tax bill. A person can also talk you out of selling during a crash. The SEC notes that these services may not have been tested under stressed market conditions.
The tradeoff is price and reach. Human advice commonly costs around 1% of assets a year, stacked on top of fund expenses the same way. That is several times what an automated service charges. The question is whether yours is the narrow one the algorithm was built for.
