Robo Advisor VS Index Funds – Who Wins?

Jeremy BiberdorfBy: Jeremy Biberdorf

March 16, 2022March 16, 2022

Robo-Advisor VS Index Funds – Robo Investing Against Traditional Index Funds

You would almost think AI, or a robo-advisor, has a much smaller margin of error on investments, and you would be right for the most part. However, index funds have been around for a very, very long time and it holds in its profile all the components of the financial market index, which makes it very safe, right?

If you’re not sure which to go for and are wondering which is better, then we can hopefully help you find some answers.

Robo-Advisor is better forIndex fund is better for
Very easy to useLow fees
Automatic contributionsEasy to use
Accessibility and diversificationEasy to contribute regularly
Automated rebalancingBroad exposure to the market

Index funds are essentially entire portfolios that includes stocks and bonds to mirror the financial market and they track benchmark indexes such NASDAQ or S&P 500. We’re going to compare market performance from index funds with robo-advisors from Betterment and M1 Finance. We have previously put the two platforms against each other but now we’re partnering them up to go against index funds.

Robo-Advisor VS Index Funds – Head-to-Head

How do we even measure the pros and cons of robo-advisors vs index funds when the results are subject to change every year? Well, we would do so by looking at it historically and analyzing its performance.

Robo Advisors VS Vanguard S&P 500

Most brokerages and online investing platforms have included a robo-advisor option on their platforms. Robo-advisors are automated helpers that benefit regular investors and do not cost as much as in-person advisors. Aside from the low costs, they also follow algorithms that produce optimized investment strategies for decent returns.

While index funds such as the Vanguard S&P 500 (VOO) are known for stability and long-term returns, robo-advisors are slowly reaching that standard as well. For VOO specifically, the returns are around 14% compound annual return. This is a steady measurement with some deviation (13.17%).

It’s important to note that other than annual returns, robo-advisors provide additional benefits. Once you take this into consideration, these extra features could equal higher returns than the VOO. What are some of these additional benefits we speak of?

  • Lower fees (compared to human advisors)
  • Tax-loss harvesting
  • Automatic rebalancing
  • Uses Nobel prize-winning investment theory algorithms (Betterment and many other robo-advisors)
  • Low to $0 minimum investment
  • Portfolio management based on your risk tolerance
  • Unbiased investment strategies

Robo Advisors VS Fidelity ZERO Large Cap Index

The Fidelity ZERO Large Cap Index, or FNILX, has a year-to-date return of around 8.23%, which is pretty average. As of Jan 2019, the best 1-year total return was at 31.79%, which also happens to be one of the index’s best.

That over 30% return might look very inviting indeed, but keep in mind that that is one single year, and not the average. It’s possible for investors to reach that height of return with a robo-advisor as well, but it depends on your portfolio settings. How risk aversive are you, and are you more heavily invested in a certain industry? These are all questions that could influence your robo-advisor’s rate of return.

Robo Advisors VS Shelton NASDAQ-100 Index Direct

Most robo-advisors follow investment strategies of large index funds, which includes the Shelton NASDAQ-100 Index Direct, or NASDX. Let’s take a look at the NASDX performance in the last 30 years. The index fund has given its investors a 10.72% stock market return, which is about 8.29% if you want to take inflation into consideration.

When you look at the returns of an index fund over a longer historical period, then you can get a clearer picture of its true potential. A 10% rate of return is considered average and is definitely something a robo-advisor can match or even beat depending on your profile settings.

When you consider that Betterment and M1 Finance AI advisors follow the strategies of these index funds, it’s safe to say that they also assess their past performances to try and “improve” them. These considerations could reflect in your robo-advisor-managed portfolio to give you an edge over traditional index funds. Again, it all depends on your investment portfolio settings.

Final Takeaway 

Robo-advisors are the top choice for diversification, automated rebalancing and tax-loss harvesting, among many other features. They are accessible, do not cost as much as a  human advisor, and can help make unbiased and unemotional investment decisions. When compared to index funds, robo-advisors can outdo them with the right settings. The two of the best and most reliable robo-advisors are the ones on M1 Finance or Betterment. Click on the links to find out what their AI advisors can do for you!

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Jeremy Biberdorf
Jeremy Biberdorf

About the Author:

Jeremy Biberdorf is the founder of Modest Money. He's a father of 2 beautiful girls, a dog owner, a long-time online entrepreneur and an investing enthusiast.

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