Robo-Advisor vs. Mutual Fund: What’s the Difference? (2024)

Investing is a key part of building wealth over the long run, but constructing and maintaining an investment portfolio can be difficult. To properly diversify, you should own dozens of different securities, but managing a portfolio like that can lead to a lot of headaches.

Mutual funds and robo-advisors are two ways that investors can get help building and managing a portfolio. Mutual funds serve as a sort of prebuilt portfolio that investors can buy into, with professional managers who handle the day-to-day management and rebalancing. Robo-advisors, on the other hand, are computer programs that construct an investment portfolio for investors based on their specific situation.

Robo-Advisor vs. Mutual Fund: Key Differences

Many investors turn to robo-advisors and mutual funds for help with managing their investments. To decide which is right for you, it’s important to understand the key differences between them.

Fees

One of the first things to think about with any investment service is the cost. Fees play a huge role in determining your long-term investment returns. Even a small difference in fees can compound to huge amounts over 10, 20, or 30 years.

For example, Wealthfront is a robo-advisor that charges a 0.25% fee annually. The Vanguard Wellesley Income Fund (VWINX) charges an expense ratio of 0.23% annually.

Keep in mind that robo-advisors typically build your portfolio by investing your money in mutual funds or exchange-traded funds (ETFs). This means that you pay the management fee to your robo-advisor on top of the expense ratio charged by the mutual funds that the robo-advisor places your money in. Thus, robo-advisors will often be more expensive than investing in mutual funds directly.

Mutual fund expense ratios can vary widely. Some, typically passively managed funds, have very low or even no expense ratio. Others, usually actively managed funds, can charge 1% or more.

Investment Strategies

Mutual funds can have a wide variety of investment strategies. You can learn about the strategy and objectives of a fund by reading its prospectus. Some funds try to mimic the returns of a specific index that they track. Others focus on buying companies that have a history of increasing dividends. Yet others simply try to find undervalued companies to buy low and sell high.

Investors can examine different mutual funds and try to find one that aligns with their specific investment goals. For example, an investor looking for higher returns may be more interested in a fund that has a heavier focus on growth stocks than one that invests mostly in bonds.

Robo-advisors can adjust their investment strategy to the needs of each investor, building a portfolio that aligns with that investor’s goals. For example, a robo-advisor would likely build very different portfolios for a 25-year-old hoping to invest for the long term and a 65-year-old who wants to produce income in retirement.

Personalization

A major advantage that robo-advisors have over mutual funds is personalization. Think of it as the difference between having a private chef and going to a restaurant.

Just as a private chef can make whatever meal you want, a robo-advisor can customize your investment portfolio based on your specific situation and desires.

When you visit a restaurant, you can only order off the menu. When investing in mutual funds, you can only look at the selection of funds available, consider their investment strategies, and invest in the one that aligns most closely with your goals. You can’t make customizations to their strategies.

Minimum Investment

Many investments have minimum investment requirements. To start investing, you’ll need to have enough money to hit that minimum.

Minimum balance requirements vary by robo-advisor and by mutual fund.

For example, Wealthfront has a $500 minimum investment. Its robo-advisor competition, Betterment, has no minimum balance requirement but does require that investors have at least $100,000 in their portfolios to access its Premium service.

A small number of mutual funds have no minimum investment requirement, but more typical minimums are in the $1,000 to $3,000 range.

What Is a Robo-Advisor?

A robo-advisor is a specialized computer program that helps investors construct and manage their investment portfolios.

To start using a robo-advisor, you usually have to fill out a survey, giving it information such as your age, income, debts, financial situation, risk tolerance, and future goals. The robo-advisor sends your data through an algorithm that produces a portfolio to help you achieve those goals.

After that, the program manages your portfolio for you. It invests when you deposit money and sells shares when needed to cover withdrawals. It also handles rebalancing and other day-to-day portfolio management.

Robo-Advisor: Advantages and Disadvantages

Robo-advisors offer significant benefits to investors, but you need to consider the drawbacks before you sign up.

Pros of Robo-Advisors

Robo-advisors are a good solution for people who want to be hands-off with their investing while still getting a personalized portfolio designed for their specific situation. Once you go through the process of opening an account and telling the program about your finances, all you have to do is make deposits and withdrawals and check your performance on occasion.

They also tend to be cheaper than working with a human financial advisor, making them a good option for cost-conscious people who want more hand-holding rather than managing their own investments independently.

Cons of Robo-Advisors

Robo-advisors usually build portfolios by investing in a variety of mutual funds or ETFs. They also charge management fees. This means that you’ll tend to pay more when you use a robo-advisor because you have to pay the expense ratio of the mutual funds that the robo-advisor invests in for you, as well as the fee charged by the robo-advisor.

You also have to consider that robo-advisors aren’t human. They’re only as good as their programming and the data that you give them. If you don’t answer a robo-advisor’s questions honestly and accurately, or if your financial situation changes, then it may not have built the right portfolio for you.

If you were investing directly in a mutual fund instead, you might notice sooner when the fund’s objectives and strategy stop aligning with your goals.

What Is a Mutual Fund?

Mutual funds help investors easily build a diverse investment portfolio. They do this by pooling funds from multiple investors, then using those funds to buy stocks, bonds, and other securities. By buying shares in a mutual fund, investors get exposure to all the investments that the individual fund holds.

Different funds can have different strategies for investing. For example, you could buy shares in a fund that focuses on real estate or in a fund that tries to produce income by holding bonds. Mutual funds are managed by financial professionals and are often offered by large investment firms like Fidelity Investments or Vanguard.

One key thing for investors to know is the difference between a mutual fund and an index fund. Index funds are a type of mutual fund that are passively managed and aim to match the performance of a specific index, like the S&P 500. This lets them keep their expense ratios very low.

Some mutual funds that aren’t index funds take a more active strategy, with fund managers trying to beat rather than match the market. These actively managed funds usually have much higher expense ratios than index funds.

Mutual Fund: Advantages and Disadvantages

Mutual funds tend to be cheaper than robo-advisors, but you also have to consider the drawbacks before deciding to invest.

Pros of Mutual Funds

Mutual funds, especially index funds and other passive, low-cost funds, can be one of the easiest and least expensive ways to invest. If you can find a fund that has an investment strategy that matches your risk tolerance and goals, it can be an all-in-one solution for your investing portfolio.

They also provide the benefit of professional management. You don’t have to buy dozens of individual securities and rebalance your portfolio regularly. You can rely on the fund managers to handle that.

Some investment companies also offer perks as you invest more in their mutual funds. For example, as your balance in Fidelity mutual funds grows, you can get more rewards from the company’s credit card and get complimentary identity theft insurance.

Cons of Mutual Funds

The greatest drawback of mutual funds compared to robo-advisors is the lack of personalization. You might find a fund that matches your strategy and goals, but there’s no guarantee that will happen.

Robo-advisors can easily personalize your portfolio for you, building one designed specifically to reach your goals.

Also, in some cases, mutual fund expense ratios—especially for actively managed funds—can get quite high. Given that robo-advisors typically build portfolios using low-cost index funds, investing in these mutual funds may be more expensive than using a robo-advisor.

Robo-Advisor vs. Mutual Fund: Which Is Best for Me?

Mutual funds and robo-advisors can both be a good way to invest, so you’ll have to think carefully to decide on which to use.

On one hand, if you want the most hands-off way to invest, then a robo-advisor is the way to go. It will build and manage your portfolio entirely on its own. If you want to use mutual funds, investing is relatively easy, but you do have to put in the effort to find the right funds to invest in.

The best robo-advisors also offer some additional benefits and services. A popular offering is tax-loss harvesting, which they argue can increase your returns, often by enough to more than cover the fees that they charge.

On the other hand, if you want to keep your costs as low as possible, then mutual funds are likely a better fit. If you have relatively simple goals or don’t have the large amounts of money necessary to get significant benefits from strategies like tax-loss harvesting, using a robo-advisor might be overkill.

The Bottom Line

Robo-advisors and mutual funds are two options for investors who want to avoid the day-to-day aspects of managing their portfolios. Robo-advisors in general tend to be more expensive but can build personalized portfolios and offer services like tax-loss harvesting. Mutual funds offer the benefit of professional portfolio management, but you’ll have to put in the effort to find the right fund for your needs.