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How do robo-advisors measure up against the long-standing benchmark S&P 500 Index? That depends on various factors, including how a robo-advisor is directed to invest by an investor’s criteria, such as financial goals, investment profile, and risk tolerance.
If a robo-advisor, based on an investor’s criteria, invests passively with the primary aim of tracking the S&P 500, then it should most likely provide a return in line with that target.
If it selects investments other than S&P 500 index funds to meet different objectives, then it could beat the S&P 500 or underperform it. The outcome would be affected by returns of other types of funds and securities, as well as market conditions related to volatility, the state of the economy, and more.
For more than a decade, robo-advisors have been becoming an increasingly common way for everyday investors to get involved in the financial markets (although that growth may be waning).
They leverage algorithms to build optimized portfolios for their users, offering a low-cost, hands-off investment solution.
Key Takeaways
- The performance of robo-advisors vs. the S&P 500 depends on whether robo-advisors implement passive strategies that track that index.
- These automated advisors build portfolios and manage them based on an investor’s financial goals, risk tolerance, and investment timeline.
- While robo-advisors primarily implement passive investment strategies, some can also incorporate active management.
- Choosing between a robo-advisor or investing in S&P 500 index funds yourself comes down to personal financial goals, risk tolerance, and investment style.
Can Robo-Advisors Beat the Market?
How They Work
The basic premise of a robo-advisor is straightforward: These digital platforms use algorithms to make investment decisions on behalf of users.
After taking into account an investor’s financial goals, risk tolerance, and time horizon, the robo-advisor allocates their funds across a diverse range of assets, usually through low-cost index exchange-traded funds (index ETFs).
These funds could include everything from stocks and bonds to real estate investment trusts and commodities.
Once the initial allocation is made, the robo-advisor monitors the portfolio and rebalances it as necessary to maintain the investor’s desired asset mix.
Robo-advisors construct well-diversified portfolios that often follow the principles of Modern Portfolio Theory (MPT).
MPT’s premise is that all portfolios, including aggressive ones, should be diversified across different assets and asset classes to minimize risk. For example, they could be invested in broad-based U.S. stocks (say, an S&P 500 ETF) as well as in smaller cap stocks, Treasury and/or corporate bonds, international securities, and cash equivalents.
Some robo-advisors may combine automated investing with investment assistance and active investment management from human professionals.
Can They Outperform the Market?
Whether or not a robo-advisor beats the S&P 500 Index depends on the type of portfolio it builds and maintains.
If a robo-advisor-built portfolio invests in securities other than those that track the S&P 500 Index, then it could outperform the market, depending on how well those other securities do. It could also underperform the market, if those securities turn in a disappointing performance.
In addition, an individual robo-advisor’s success can depend on its ability to interpret the criteria set by an investor and the effectiveness of its algorithms.
Whether or not a robo-advisor beats the market depends on the types of securities it invests in, the allocations of each asset type/class, and the quality of its algorithms.
Factors That Affect Robo-Advisor Performance
Portfolio Components
One factor that impacts robo-advisor performance is the composition of the portfolio it builds and manages.
Unlike investing in just an S&P 500 index fund specifically to track the S&P 500, robo-advisors create diversified portfolios that include a range of asset classes, such as domestic and international equities, bonds, commodities, and real estate.
The particular breakdown of this composition should tie to an investor’s risk tolerance, time horizon, and financial goals.
This means that the performance of a robo-advised portfolio is tied to more than the performance of the S&P 500 or any other single market index.
For instance, on one hand, an investor with a high risk tolerance may have a portfolio with a larger allocation to equities, which have historically provided higher returns but also come with greater volatility.
But this, too, would include more than just the S&P 500 Index-tracking investments, with allocations to others such as the small-cap Russell 2000 or the tech-heavy Nasdaq 100.
On the other hand, a more risk-averse investor might have a more significant portion of their portfolio in bonds, which can offer more stable returns.
The composition of the portfolio will significantly impact the performance of a robo-advised investment.
Tracking Errors of Specific Funds
Another factor that can influence robo-advisor performance is the specific exchange-traded funds (ETFs) that they use to build their portfolios.
Even ETFs that track the same benchmark can have different levels of tracking error, which is the divergence between the ETF’s performance and the performance of the benchmark that it’s supposed to track.
The amount of tracking error can be influenced by a variety of factors, such as the ETF’s expense ratio, its method of replicating the benchmark, and the liquidity of the securities it holds. Therefore, the choice of ETFs by the robo-advisor can impact the overall portfolio performance.
Rebalancing
Another consideration is the rebalancing strategy employed by the robo-advisor. Rebalancing is the process of realigning the allocations of a portfolio’s assets to maintain the desired levels of risk and return. Allocations can change due to the performance of their assets.
By regularly rebalancing, robo-advisors ensure that the portfolio doesn’t drift too far from its target allocation. However, the frequency and method of rebalancing can impact transaction costs and tax efficiency, which in turn affect the net return of the investment.
Historically, professional investment management was available primarily to wealthy individuals or large institutions. Robo-advisors changed the game, offering the benefits of automated, algorithmic investment management to everyone. This access, along with lower fees, have made robo-advisors a popular choice for some investors.
Factors That Affect the S&P 500 Index Performance
What Is the S&P 500 Index?
The S&P 500 is a popular stock market index that serves as one of the primary benchmarks for the U.S. stock market. It tracks the performance of 500 large-cap companies listed on stock exchanges in the U.S. As the performances of its components change, so does the return measured by the index.
The index is widely regarded as the best single performance gauge of large-cap U.S. equities and a reliable indicator of the health of the nation’s economy. The S&P 500 includes firms from all sectors of the economy, making it a representative snapshot of the overall U.S. stock market.
The composition of the S&P 500 is not arbitrary. It’s constructed and regularly updated by a committee at Standard & Poor’s, a provider of indexes and credit ratings.
Companies are selected based on specific eligibility criteria, including market capitalization, liquidity, domicile, financial viability, and length of time as a publicly traded stock.
Company Values Impact the Index
Importantly, the S&P 500 is a market-capitalization-weighted index, which means that larger companies account for a greater portion of the index. Therefore, the performance of the largest companies will have a more significant impact on the performance of the S&P 500 Index as a whole.
Macroeconomic conditions, such as the health of the economy, inflation rates, and monetary policy can drive broad-based market trends that impact all companies in the index.
Corporate earnings also play a crucial role, as strong earnings can boost stock prices, while weak earnings can drag them down.
Additionally, geopolitical events, changes in consumer behavior, technological advancements, and other sector-specific trends can influence the performance of individual companies and, consequently, the overall performance of the S&P 500.
Robo-Advisor Returns vs. S&P 500 Index Performance
Condor Capital Wealth Management details the portfolio returns of top robo-advisors in the U.S. While most robo-advisor portfolios have a mix of large-cap equities and other assets, the firm offers data for equity-only returns. With this data, we can compare that portion of overall performance to the S&P 500.
According to Condor Capital, the S&P 500 Index turned in a performance of 25% for the 2024. Here are the top 10 trailing one-year returns for the robo-advisors (some of which also offer assistance from professional advisors).
| Robo-Advisor Equity Portfolio Returns (2024) | |
|---|---|
| Robo-Advisor Portfolio | Return as of 12/31/24 |
| SoFi | 20.36% |
| TD Automated Trading | 18.67% |
| Betterment Climate Impact SRI | 18.64% |
| US Bank Automated Investor | 18.21% |
| Zack’s Advantage | 18.08% |
| Wealthfront | 18.07% |
| Fidelity Go | 17.78% |
| Acorns | 17.73% |
| Merrill Guided Investing SRI | 17.72% |
| Vanguard Personal Advisor | 17.71% |
Robo-Advisor vs. S&P 500: Which Is Right for You?
Comparing robo-advisors to the return for the S&P 500 Index isn’t an apples-to-apples comparison.
The S&P 500 is a broad market index. Robo-advisors are automated digital platforms that can invest in a range of assets, often including an allocation to S&P 500 index funds.
Investing using robo-advisors or S&P 500 index funds offers unique advantages and potential downsides. The choice between the two should be based on your investing style and preferences, and your investment goals and risk tolerance.
Investing directly in the S&P 500, through an index mutual fund or an ETF, has its merits. It offers a straightforward and low-cost way to gain exposure to much of the U.S. stock market’s growth potential.
However, investing solely in the S&P 500 also means that your portfolio is not diversified beyond the scope of large-cap U.S. stocks. This can expose you to certain risks that greater diversification can help mitigate.
The best robo-advisors offer some advantages over investing solely in S&P 500 index funds:
- They typically provide a level of diversification that you wouldn’t get from investing in any single index. By spreading investments across various asset classes, robo-advisors can help reduce risk and potentially smooth out returns over time.
- They automate many aspects of the investment process, such as investment selection, portfolio rebalancing, and tax-loss harvesting, which can benefit investors who prefer a more hands-off approach.
However, robo-advisors do come with management fees, which, although quite modest, can eat into your returns over time because they’re tied to the growing value of your assets.
Do Robo-Advisors Beat the S&P 500?
Some robo-advisor portfolios may outperform the S&P 500 in certain years or in specific market conditions, while in others, they may underperform.
Is Self-Directed Investing in the S&P 500 Better than a Financial Advisor?
If your sole goal is to invest in the U.S. stock market, you can invest on your own in a low-cost fund that tracks the S&P 500. However, if you need more or comprehensive financial advice and guidance, a financial advisor could be worth the additional cost.
Should I Use a Robo-Advisor for an Index Fund?
What Is a Disadvantage of Using a Robo-Advisor?
While robo-advisors offer a convenient, low-cost, hands-off approach to investing, they often lack the flexibility and autonomy of self-directed investing, and the personalized advice and human touch that a traditional financial advisor can provide.
The Bottom Line
How do robo-advisors perform compared to the S&P 500 Index? That depends on the securities that a robo-advisor uses to build a particular portfolio.
Often, a robo-advisor-built portfolio will contain securities that include those in the S&P 500 as well as other types of assets and asset classes.
Therefore, the robo-advisor portfolio could outperform or underperform this broad market index, depending primarily on the performance of these other securities.
