How Online Brokerages Compare to Robo-Advisors

Robo-advisors are auto-investment companies that are positioning themselves as competitors of traditional investment managers. They offer similar investment management services at comparatively lower and more transparent fee structures with algorithm-driven portfolios. While not a direct competitor of online brokerages - which often pitch very low transaction fees - robo-advisors can be a credible alternative to brokers for beginning investors looking for guidance in investing. 

Unlike online brokerages where investments are self-directed, many robo-advisors manage investments for the investor. In general, robo-advisors use a questionnaire to determine the investor’s risk level (i.e. comfort with the possibility of losing capital in pursuit of investment returns) and assign different algorithm-generated and managed portfolios to investors depending on their answers in the questionnaire. 

How are Robo-Advisors Different from Discount Online Brokerages?

There are three main areas that we'll highlight as differences for investors deciding between an online broker or a robo-advisor:

Investment decisions: The major difference between robo-advisors and online brokerages is that the former manages your investment portfolio for you. Robo-advisors act like investment managers; they pick investments for your portfolio with algorithms based on the investor’s risk profile and goals. Online brokerages, on the other hand, highlights investor autonomy - the investor chooses which assets (stocks, bonds, ETFs) to invest in. 

Minimum investable funds requirement: More than 70% of the brokerages we looked at in our study of online brokerages do not have a minimum amount requirement. Unlike online brokerages, many robo-advisors set a minimum investment requirement upwards of $10,000. WiseBanyan is unique among the robo-advisors we looked at since it does not impose a minimum amount requirement AND does not charge any fees for its basic advisory services. 

Fee structure: Robo-advisors highlight relatively low service fees - between 0.15% to 0.75% of investment funds - compared to traditional investment managers’ fees which average between 1% to 2% of investment funds annually. Online brokerages usually emphasize low transaction fees (also called base-trade fees or fee-per-trade) while charging for other services besides trading as “one-off”s.

Advantages of Robo-Advisor versus Traditional Online Brokerage

Access to investment advice and a managed portfolio: Robo-advisories essentially offer portfolio management services once exclusively available to investors with large sums of investable funds. The investment advice provided is based on the investor’s age, investment horizon and goals, and a holistic view on the investor’s entire investment portfolio. While the advice provided by robo-advisors is not completely tailored for every individual situation, the management service is good enough for new investors with simple financial situations. Additionally, robo-advisors also rebalance the investor’s portfolio periodically based on changes in the market or the investor’s situation, a move sometimes neglected by self-driven investors. 

Diversification: Across the board, robo-advisors invest in ETFs and index funds, allowing for diversification in an investor’s portfolio. Many robo-advisors limit the number of decisions an investor can make regarding investments, some only allowing an investor to change the risk level they are comfortable with. While this may sound undesirable, it actually helps protect the portfolio from emotionally-driven decisions that could lead to lower investment returns. Many new investors own individual stocks in online brokerage accounts. While this approach may bring high returns if you’ve picked the “right” stock, it also concentrates the risk of significant chunks of your portfolio.

Disadvantages of Robo-Advisories

Not-so-low minimum requirements: Many robo-advisors require minimum investable funds, and this may be a barrier for new investors with funds smaller than $10,000. However, startups like WiseBanyan have done away with minimums and fees altogether, and we think this is an exciting development in the auto-investing service landscape. Betterment, for example, requires investors with balances under $10,000 to pay an additional monthly fee of $3 per month, which will be waived with monthly auto-deposits of $100 or more. 

Why do traditional investment managers require large investable funds? Investment managers rely on investing professionals and personalized service, thus requiring bigger account values since fees are based on a percentage of the assets under management (AUM). With the introduction of an investing algorithm that determines investment decisions, the cost to personalizing a portfolio is radically reduced. 

New and unproven: Robo-advisories are a recent phenomenon - Wealthfront, the largest robo-advisory by assets under management (AUM) was founded in 2008. Robo-advisors are new enough that the current crop could be treated as an exercise in proof of concept. Additionally, unlike bank deposits, investment accounts are not guaranteed by the FDIC and the investors bear the risk of losing the entire value of their account, or worse, losing their assets should the company fold. Bear in mind this is also true for online brokerage accounts; however, online brokerages have been around long enough to signal that the business model works. 

Cost Comparison between Online Brokerage and Robo-Advisory

In this scenario, we assumed that the investor has at least $10,000 to invest. We chose this amount since many, but not all, robo-advisors require a minimum of $10,000 to open an account. We picked robo-advisors which charge the lowest management fees and compared them with the online brokerage with the lowest trading fees. We assumed that portfolios are rebalanced twice annually, and that it would take on average five trades using an online brokerage account. We included the average ETF/fund expense ratios as well - these are fees that would be charged by the fund companies regardless of the platform the funds are traded on (we looked at the best online brokerages for commission-free ETFs here).

Our simple comparison considers basic account costs, and does not factor potential returns based on different investment strategies. Based on this comparison, if you have $10,000 or more of investable funds, you pay lower fees with robo-advisors WiseBanyan than you would at the discount online brokerage TradeKing. As we mentioned earlier, WiseBanyan is unique in that it charges no fees at all for its core services.

Wealthfront charges comparable fees with the online brokerage, but you would theoretically be getting more services at Wealthfront than you would at TradeKing. Overall, if you have $10,000 or more in investable funds and prefer not to think about it too much, choosing a robo-advisor over a self-directed account is a worthwhile move.

Types of Fees Robo Advisors Online Brokerage
WiseBanyan  WealthFront  Betterment  TradeKing 
Funds to be invested $10,000 $10,000 $10,000 $10,000
Fee per transaction n/a n/a n/a 4.95
Transaction fees (Rebalance 2x/year, 5 transactions) n/a n/a n/a 24.75
Annual service fees (% of funds) 0 0.25% 0.35% n/a
Annual service fees ($) 0 25 35 0
Average ETF expense ratio (% of funds) Absorbed 0.12% 0.15% 0.40%
Average ETF/fund fees ($) 0 12 15 40
Total Fees ($) 0 37 50 40
Total Fees (% of funds) 0 0.37% 0.50% 0.40%

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