ETFs vs. Robo-Advisors: What’s the Difference?

Robo-advisors provide tailored advice to help you optimize your portfolio, but with exchange-traded funds (ETFs), it’s up to you to determine the types of assets that will best help you reach your investment goals. The huge variety of ETFs on the market allows you to invest in targeted areas of the market, but unlike robo-advisors, the funds themselves do not provide any sort of guidance.

If you’re considering investing in ETFs or using a robo-advisor, you’ll want a clear sense of how these financial products work and what they offer. Let’s compare ETFs with robo-advisors, highlighting how they might fit into your investment strategy while considering the drawbacks of each approach.

ETF vs. Robo-Advisor: Key Differences

The main distinction between an ETF and a robo-advisor revolves around the level of guidance provided to the investor. ETFs allow you to focus your portfolio on certain areas of the market, but if you’re investing on your own, it’s entirely up to you to decide which funds to buy. A robo-advisor allows you to automate investment decisions by recommending a portfolio that’s customized to help you meet your investment goals.

Since robo-advisors provide this additional service, it’s probably no surprise that they tend to carry higher fees. As an example, a basic plan with robo-advisor pioneer Betterment charges an annual fee totaling 0.25% of your invested balance. In comparison, the expense ratio of the SPDR S&P 500 Trust (SPY), the world’s largest ETF, is just 0.0945%.

What Is an ETF?

An exchange-traded fund (ETF) is a type of pooled investment—a security made up of a basket of other financial instruments. Unlike mutual funds, their pooled investment cousins, ETFs trade on exchanges just like individual stocks, fluctuating in value throughout the day. ETFs provide a cost-effective and liquid vehicle to invest in multiple underlying assets targeting a specific area of the market.

When ETFs burst onto the scene in the 1990s, they provided a low-cost, easy way to invest in a group of securities or a market index. Investors have continued to pour funds into ETFs at breathtaking speed, with funds in ETFs reaching $11 trillion in assets under management (AUM) at the end of 2022. Growth at the current pace would see the AUM in ETFs double by 2027.

More recently, a newer type of investment product has experienced similar levels of explosive growth: the robo-advisor. Just as their name implies, robo-advisors are automated alternatives to traditional financial advice. Since the first ones launched in 2008, the digital platforms designed to help investors build customized portfolios based on their financial goals have already grown to $3 trillion in AUM.

The huge variety of ETFs on the market makes it possible to invest in diversified sets of assets from across the investing spectrum. You can find ETFs that focus on stocks, commodities, and bonds. You might choose a fund that tracks a broad market index like the iShares Russell 3000 Fund (IWV), which is an ETF that tracks the Russell 3000. Or you could opt to home in on a specific sector like energy and invest in it through an ETF like the Energy Select Sector SPDR Fund (XLE). For a specific geographical sector like Japan, the iShares MSCI Japan Fund (EWJ) would give exposure to that region.

Most ETFs are passively managed, designed to replicate the performance of an underlying index. The ETFs that do operate with active management strategies typically have a higher expense ratio—the percentage that investors pay in fees for administrative and operating expenses.

What Is a Robo-Advisor?

A robo-advisor is a digital platform that uses algorithms to deliver personalized investment planning services. Investors typically complete an online survey that assesses factors like their financial goals, time horizons, and levels of risk tolerance. Then, the robo-advisor uses proprietary data to construct a portfolio that is optimized to meet that investor’s needs.

Working with a robo-advisor allows you to access professional investment management services with a lower price tag than you would pay for working with a human advisor. Some of the best robo-advisors can even automate other aspects of your strategy like tax-loss harvesting—when you strategically sell assets at a loss to offset your taxable gains on other investments.

ETF: Advantages and Disadvantages

ETFs have become an increasingly popular way to invest because they provide an easy-to-trade and low-fee vehicle for investing in a basket of securities. The huge array of ETFs available—tracking everything from broad swaths of the market to specific industries and investment themes—opens the door to a seemingly infinite realm of possibilities. Whether you’re approaching the market with broad strokes or surgical precision, ETFs allow you plenty of flexibility to enact your investment strategy.

On the downside, investing in ETFs can require a lot of legwork, consistently researching investment opportunities and keeping an eye on your portfolio. While ETF fees tend to be reasonable and are often lower than those on other investments, paying for a fund’s administrative and operating expenses can eat into your profits. Luckily, many brokerage platforms now offer commission-free ETF trading, but it’s still important to be aware of any transaction costs.

Robo-Advisor: Advantages and Disadvantages

Robo-advisors offer a significant cost advantage compared with traditional, human financial advisors, making professional investment management more accessible to a broader public. Most robo-advisors adopt some form of Modern Portfolio Theory (MPT), aiming to maximize returns while sticking within the investor’s threshold for risk—algorithmically developing a strategy that is tailored to an individual’s needs. Some robo-advisors can even help investors adjust their portfolios via rebalancing and tax-loss harvesting.

The main critique of robo-advisors is that, although they offer some level of personalization, they lack the human touch and are incapable of seeing the full picture when analyzing an individual’s financial situation. For instance, robo-advisors are less capable than their human counterparts of accounting for tax planning and estate planning issues. Robo-advisors may also limit investors to a restricted set of investments, making them less appropriate for investors interested in alternative investments or strategies.

ETF vs. Robo-Advisor: Which Is Right for Me?

If you’re considering investing in ETFs or using a robo-advisor to help you build your portfolio, the decision hinges on the amount of self-control or external guidance that you’re comfortable with on your investing journey.

On one hand, if you have the time and the knowledge to research and monitor your investments, you might turn to ETFs as a component or even the backbone of your strategy. On the other hand, if you lack experience or prefer more input, it might be worth working with a robo-advisor to help you align your investments with your goals.

The Bottom Line

ETFs and robo-advisors are tools for investing that have grown substantially in recent years. ETFs provide low-cost, diversified exposure to a collection of assets, typically designed to replicate the performance of an underlying market index. Robo-advisors, meanwhile, are digital platforms that can help you tailor a portfolio that aligns with your goals—all at a lower cost than working with a human advisor. Robo-advisors offer guidance and support to help with your investment strategy, while do-it-yourself ETF investing gives you more flexibility and control without providing any personalized advice.