Robo-Advisors vs. Target-Date Funds: Which Is Right for You?

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August 5, 2022, 9:00 AM

SmartAsset: Robo-Advisors vs. Target-Date Funds

While most people understand that investing is indispensable for a comfortable retirement, where and how to invest your money can be less clear. Fortunately, more tools and services are available to the average investor than ever before. Robo-advisors and target-date funds are generally inexpensive ways to acquire a diversified portfolio that can be foundational for your retirement.

A financial advisor could help you create a financial plan for your investing and savings goals.

What Are Robo-Advisors?

Robo-advisors are electronic investment advisors. With a robo-advisor, you’ll first submit your personal information and financial goals. Then, the robo-advisor will offer an investment strategy based on your timeline, risk tolerance, and other factors. Once you select your investment approach, the robo-advisor’s algorithm will passively manage the fund.

As with any other investment method, robo-advisors bring advantages and disadvantages to the table, including:

Pros

  • With a robo-advisor, your portfolio usually consists of exchange-traded funds (ETFs) containing hundreds of securities. As a result, robo-advisors automatically diversify your investments, which is crucial for the health of almost any investment fund.

  • Your robo-advisor will often set your account to mirror the performance of a primary stock index, such as the S&P 500, which outperforms many actively managed funds.

  • Robo-advisors generally cost less than other investment services. Depending on the company, you can expect to pay between 0.25% and 0.5% of your investment fund annually.

  • Robo-advisors perform tax-loss harvesting for taxable investment accounts, which can help you offset investment losses.

  • There are usually low or no minimums for creating an investment account, meaning investors with $1 can get started with some robo-advisors.

  • Robo-advisors offer accounts for purposes other than retirement, such as education or travel.

Cons

  • Every company charges different fees, which might eat into your gains significantly if you haven’t read the fine print.

  • A passively managed fund that follows primary stock indexes will never beat the market, potentially limiting your gains.

  • Though they may be free nominally, some robo-advisors run by banks may require you to have a savings or checking account or otherwise put some of your money into the institution instead.

What Are Target Date Funds?

SmartAsset: Robo-Advisors vs. Target-Date Funds

Target-date funds (TDFs) also offer diversified investments but require only one piece of information to get started: your age. Then, based on how far away you are from retirement, the TDF will shift your allocations: aggressive if you’re younger with decades before you leave the workforce, or more conservative if retirement is just around the corner. With each passing year, your TDF’s allocation will change to match your approaching retirement. This trajectory from high-risk, high-reward to low-yield stability is known as the glide path, the signature feature of TDFs.

Financial professionals actively manage TDFs. Therefore, they have their own strengths and weaknesses:

Pros

  • TDFs have low fees. Morningstar’s landscape report on TDFs measured their average annual expense ratio as 0.34% at the end of 2021.

  • Once you submit your age, you don’t have further action to take with your fund, which eliminates the stress of trying to navigate the investing world.

  • The fund automatically allocates more low-risk assets as you age, protecting your gains from market volatility.

  • Actively managed funds have a chance to beat the stock market, earning you potentially higher returns.

Cons

  • As with robo-advisors, some TDFs charge high fees, reducing your real return.

  • No personalization other than taking your age into account. For example, if two investors of the same age invest in the same TDF, their allocations will be identical.

  • Passively managed funds and major stock indexes regularly beat actively managed funds, meaning you could pay for investing services that hurt you in the long run.

  • Minimums can be $1,000 or more to start investing.

Robo-Advisors vs. Target-Date Funds: Key Differences

Robo-advisors and TDFs are aligned in many respects, but the distinctions can make one a wiser choice based on your financial situation. Here are six things to keep in mind:

Personal touch. Because you submit information about your financial situation and goals, you get a degree of individualization with robo-advisors that TDFs don’t offer.

Hands-on capabilities. Robo-advisors aren’t quite a set-it-and-forget-it investment like TDFs, which you don’t control. Depending on your preferences, the degree of customization and control can be a blessing and a curse.

Allocation possibilities. Certain TDFs offer a further degree of diversification through holdings in other assets, such as commodities and real estate. However, many companies offer TDFs that prioritize in-house mutual funds, which can limit the choices of the professional overseeing your account.

Active vs. passive management. Robo-advisors offer passively managed funds, which follow the stock market’s trajectory instead of trying to surpass it. This approach drives down costs and offers somewhat more reliable returns (of course, there are no guarantees in investing). On the other hand, TDFs employ financial professionals who try to find opportunities in the market to boost your gains. As a result, you could find a TDF with low fees and higher potential gains. However, beating the market is challenging, to say the least.

Wide-ranging costs. Costs between the two are challenging to gauge overall, and the specific companies you’re considering will give you a better idea of how much each will cost you.

Minimum barriers. On average, robo-advisors have low to no minimums, allowing more people to start investing for retirement. TDFs often have higher minimum requirements, but this isn’t always the case.

Bottom Line

SmartAsset: Robo-Advisors vs. Target-Date Funds

Robo-advisors and TDFs offer investors diversified, often low-fee funds that can provide solid gains. Investors who want more personalization, customization, and passive management may prefer a robo-advisor. Conversely, suppose you want to devote less thought to your portfolio. In that case, TDFs require minimal personal information, and financial professionals will invest your money based on how near you are to retirement. Of course, fees, minimums, and other details vary by company. So, like with every crucial financial choice, research is essential.

Tips for Investing With Robo-Advisors and TDFs

  • A financial advisor can help you create a financial plan for your needs and goals. SmartAsset’s free tool matches you with up to three financial advisors who serve your area, and you can interview your advisor matches at no cost to decide which one is right for you. If you’re ready to find an advisor who can help you achieve your financial goals, get started now.

  • Robo-advisors and TDFs may be less expensive than other investment choices, but they aren’t free. Instead of paying for an investment service, you could start your own portfolio. It may sound intimidating, but if you have the time to learn, you can become proficient in the basics of trading, such as asset allocation.

  • Planning for retirement is a challenge, and losing track of the details can be easy. For example, although Social Security likely won’t afford you enough money to fund your retirement, it can help quite a bit. In turn, it’s important to include your projected Social Security earnings in your retirement savings projections. To get a glimpse of what you can expect, visit the SmartAsset Social Security calculator.

Photo credit: iStock.com/whyframestudio, iStock.com/FatCamera, iStock.com/JLco – Julia Amaral

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