What is a robo-advisor?

Investors are increasingly choosing robo-advisors to automate their portfolio management. Let’s explore what a robo-advisor is and how you can use it for your investment purposes.

AI-powered, low-cost software known as robo-advisors are one the rise today. The takeover of bots in the classic field of wealth management is an emerging trend across the industry. Investors are increasingly choosing robo-advisors to automate their portfolio management. Let’s explore what a robo-advisor is and how you can use it for your investment purposes.

There are three ways in which, if you are an investor you’d know, you can create and manage your portfolio.

  • You can hire a financial advisor who will curate portfolios using their expertise.
  • You can do it yourself and pick investments.
  • You can use a robo-advisor to help you put together a portfolio.

We’ll be taking a closer look at the third option on the list.

What is a robo-advisor?

Robo-advisors is an AI-powered software that plays the role of financial advisors that help you with investment management or financial advice with negligible human intervention. They are also known as digital advice.

“A Robo-Advisor is a self-guided online wealth management service that provides automated investment advice at low costs and low account minimums, employing portfolio management algorithms.”

Patrick Schueffel, The Concise Fintech Compendium

The typical robo-advisor collects information from you about your financial situation and goals using an online survey. Using this data, it offers advice and recommendations and automatically invests your assets.

Some of the capabilities of a robo-advisor include (but not limited to)

-Account set up

  • Financial goal planning
  • Account services
  • Portfolio management
  • Security features
  • Customer service

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Source: Accenture Research

How does a robo-advisor work?

Like any AI-powered financial platform, algorithms are central to the functioning of a robo-advisor. An algorithm is the set of instructions that a machine uses to execute specific tasks. A robo-advisor uses algorithms and well-recognized modern portfolio management strategies to create a diversified investment portfolio for you.

Here’s how a robo-advisor algorithm works.

First, the robo-advisor identified your risk appetite to develop your investment portfolio. This, it does, using online surveys and gathers details such as your age, your tolerance for volatility, your investment goals and time horizon.

Using the information gathered and using a portfolio theory/strategy, the robo advisor invests your funds in a diversified portfolio. This portfolio can be a mix of equities – both domestic and international, bonds, real estate, etc. In the end you have a portfolio that reflects a mix of assets and is tailored to meet your investment goals.

The robo-advisor charges a percentage fee on the total portfolio value. Once the robo-advisor invests your funds, it automatically rebalances your portfolio regularly – it makes changes to your investments to align your portfolio to specific asset allocation. Some robo-advisors are capable of selling certain securities at a loss to offset profits in other securities and reduce your tax bill (a process known as tax-harvesting).

How to choose the right robo-advisor for your needs?

Now that you know what a robo-advisor is and how it works, you will want to choose a robo-advisor for your financial automation needs.

Identify your need

A robo-advisor can only automate your investments towards new financial goals based on the number of funds you are looking to invest. Your choice of a robo-advisor depends on your goals. Hence it is important that you identify what you want to achieve and what your financial goals are.

Sign up for a demo or a free trial

Most robo-advisor platforms allow you to create a free account or try the product before you begin paying for the platform. Before you commit your money, ask for a demo, or sign up for a free account to explore the platform and its capabilities.

Check for these four important criteria

Once you are done trying out a few robo-advisors, you need to evaluate them. You can so that using four key criteria

  • What are the platforms’ features or service offerings?
  • Does the platform provide unbiased, research-based advice?
  • Is it an established or trustworthy company?
  • What is the pricing model of the platform?

Stick to your choice of a robo-advisor

This one is more an advice than a step in the process of selecting a robo-advisor. Once you have identified the best robo-advisor platform for your needs, it is important that you stick to it through your investment period. Not doing so affects your financial well-being. However, if you have genuine concerns that warrant an exit, then make sure you use an alternative solution, instead of entirely abandoning the idea of automating your investments.

Benefits of using a Robo-advisor

We finally arrive at the question – what are the benefits of using a robo-advisor (read as what are the benefits of using a robo-advisor as opposed to hiring a financial advisor). We must understand that the world is headed towards innovation paired with automation. This doesn’t mean humans will be replaced by AI or bots. AI and AI-powered tools will take over tasks that can be automated. This leaves humans with a lot of time to engage in and solve more complex issues.

Some of the benefits of hiring a robo-advisor include lower costs, timely recommendations, unbiased advice, round the clock availability, and error-free bookkeeping. Let’s explore these in detail.

Lower costs

If you are a private investor or a financial firm looking to save costs on investing, then a robo-advisor is your best bet. Though they charge you a percentage of the total portfolio (usually ranging between 0.2% and 0.8%), the cost is considerably lower than that of hiring a traditional financial advisor. Additionally, the predictions and advice is more accurate since it is unbiased, unaffected by emotions, and is driven by data.

Recommendations

Traditional financial advisors are humans first. Their decisions can be affected by emotions, biases, and various other events occurring around them. This, in turn, has an effect on the advice they impart to you. With robo-advisors, this isn’t the case. They are run on algorithms and well-defined investment strategies leaving them unaffected by emotions, biases, or market indices. This means advice that is consistent and instant, all the time.

24x7 availability

One of the biggest benefits of using robo-advisors apart from automation and lower costs is that machines never sleep. This means you have access to instant advice, recommendations, or help anytime anywhere. Traditional financial advisors, on the other hand, might not be available round the clock and have their own schedule and calendar that might not play well with your needs.

Error-free record-keeping

We are prone to making errors. Isn’t that what partly makes us human? This attribute seeps into record-keeping as well. This results in investors losing track of their investments. This is where robo-advisors make a significant difference. The scope for errors is negligible. You can retrieve the minutest of details at any time and your robo-advisor will keep track of your investment plan.

Where to find a robo-advisor

If you’ve determined that automated portfolio management is right for you, here are a few robo-advisors that you can choose from based on your funds, goals, and risk appetite.

  • Betterment — charges a 0.25% fee and offers a $0 account minimum for robo-advisor services.
  • Fidelity Go — charges a 0.35% fee but requires no minimum investment.
  • Vanguard Personal Advisor Services — offers an online interface and access to a financial advisor for a 0.30% fee for assets up to $5 million. The account minimum is $50,000.
  • WealthFront — charges a 0.25% fee for robo-advisor services and requires a $500 account minimum.
  • Wealthsimple — charges a 0.50% fee and requires no account minimum.

Closing thoughts

We believe that digital-advice has already begun to have a significant impact on the wealth management industry. Several wealth managers have welcomes this technology and have already launched it for their customers or have begun using it for their investment needs. Have you used a robo-advisor and if so, what is your experience like?

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