What is a Robo Advisor?

Technology has made everything better, faster, and cheaper over the years. Investing is no exception. Today, numerous financial management companies use robots, also known as robo advisors, to advise and manage the accounts of investors.

In this article, we look at what robo advisors are and how they can benefit you.

What is a Robo Advisor?

A robo advisor is basically an automated computer program that offers financial advice. To be precise, the program manages your investments through an automated algorithm instead of hiring someone to monitor your portfolio.

Robo advisors are limited to investment trading, trade execution, and monitoring. Other aspects of financial planning are largely personal and can’t be programmed into an algorithm.

This service is normally cheaper since a person is not handling the day-to-day work of managing portfolios. Instead, the work is being done by a machine.

With a robo advisor, it’s easy to scale portfolios. One program can manage countless portfolios if it has the speed and memory to perform the executions.

Moreover, there’s instantaneous trade execution since the program doesn’t think and can execute commands at electric speed if the instructions are clear.

These features help to save time and costs, which can be spent on other things. Robo advisors can be an excellent solution for beginner investors, young professional looking to automate their portfolio, and investors who have a fairly simple situation. Retirees may also find these programs useful.

How Robo Advisors Work

When you start working with a robo advisor, you’ll be asked to provide information on your current financial situation and your future goals. Then, the robo advisor will take that data and compute where you should invest your money.

The investment recommendations are based on a particular level of market risk with the aim of achieving maximum return for a particular risk.

Robo advisors can analyze your personality to determine how it influences your risk-taking behavior in financial decisions. They employ personality insights to determine your temperament from the information you’ve provided.

The robo advisor then uses the construed personality to determine your risk tendency and select investment suggestions accordingly.

Top Robo-Advisors

There’s a wide selection of robo advisors on the market today. You want to choose a robo advisor that suits your investment needs.

While more brokerages are entering the market all the time, these are three of the best robo advisors you can consider working with:

Betterment

Betterment is the largest independent robo advisor, offering an impressive combination of goal-based tools, no account minimum, and pocket-friendly management fees. It is a great option for the beginning investor.

This robo advisor has evolved from a purely robotic tool that provides investors with a quick way to get started with investing to the hybrid robo-and-human advisor system it is today. It is robo advisor that grows with you.

As a beginner, you can start with Betterment Digital, which walks you through goal-based investing and gives you limitless access to investment professionals via chat.

Betterment also offers a Premium level, which can match you with an accredited financial planner for a one-on-one advisor relationship.

Start an account with Betterment>>

Wealthsimple

Wealthsimple is driven by the Modern Portfolio Theory. The theory focuses on minimizing risk by means of diversification and passive investing. Wealthsimple achieves that by creating portfolios of 8-10 ETFs that focus on one of ten unique asset classes.

Also, it automatically rebalances without charging an additional fee for tax-loss or professional financial advice. When you surpass $100,000 invested, you become eligible for Wealthsimple Black.

With Wealthsimple Black, you get to enjoy a reduced fee and other goodies such as access to VIP airline lounges. Wealthsimple charges a management fee of 0.5% or 0.4% for larger accounts accounts. There’s no account minimum.

Start an account with Wealthsimple>>

Bloom

Bloom will work well for you if your employer provides a retirement plan such as 401(k). You only need to pay a $10 monthly management fee, and Bloom will help you sort through the long list of investment options in your 401(k) to put together a portfolio that fits your investment needs and risk tolerance.

This robo advisor is designed to optimize your portfolio and help you eliminate any irksome hidden charges that could be lurking in your 401(k). If you have any other employer-sponsored plan such as 403(b), 401a, or 457, Bloom can also help you manage them. It’s worth noting that this robo advisor has no account minimum.

Start an account with Blooom>>

Costs

When using a robo advisor, you’ll need to pay a service fee as well as the expenses of the investments used. The cost of robo advisors vary, and they can be structured as a percentage of investments or as a fixed monthly fee.

If you choose a robo advisor that charges a fixed monthly fee, you’ll normally pay a monthly fee depending on the size of your portfolio. Conversely, with a robo advisor that charges a percentage of investments, you may need to pay about 0.15% to 0.5% of the size of your account per year.

Keep in mind that you’ll also incur the cost of any expenses related to the investment used by your robo advisor. Mutual funds and ETFs, for instance, have expense ratios. These charges are normally deducted from the assets of the fund before any returns are distributed to investors.

Shortcomings

With robo advisors, it’s imperative that you find a service that fits your investment needs perfectly. If you need a specific asset mix to feel comfortable due to your investment preferences, the algorithm should be so flexible that it allows a wide range of asset mixes. Otherwise, you may end up with an allocation that doesn’t suit your needs effectively.

This can expose you to more risk. The algorithm may not always work in extreme market conditions. If you receive an inheritance after your parent passes, for example, going online to a robo advisor to manage the money your parent left may not work effectively.

Likewise, if you put a stop loss order to sell your stock at $100 per share, and the market falls abruptly, the price might go through $100 per share for $103 to $92.

Depending on how you put the order into the algorithm, it may not get fulfilled, and you’ll have unexpected results. If you instruct the robo advisor to sell the stock at whatever price it can get, it may get the worst price as the order will be fulfilled at the extreme price changes.

Moreover, since robo advisors lack empathy and sophistication, they can only benefit individuals with small accounts and limited investment experience. They may not work for individuals who need advanced services such as estate planning, retirement planning, complicated tax management, and trust fund administration.

The fact that robo advisors don’t involve human interaction can also be a shortcoming. When working with a robo advisor, you enjoy good-performing, low-cost portfolios.

However, you lose the human touch in the process. You don’t have an advisor to walk you through tough decisions.  You also can’t interact with experienced financial planners.

Is a Robo Advisor Right for You?

If you don’t wish to be directly involved with the management of your finances and investments and don’t need any human interactions when making investment decisions, then you could use a robo advisor.

Maybe you have a busy life, thanks to a growing family, a demanding job, or health issues that are making it hard for you to focus on your finances and investments? In that situation, a robo advisor could also come in handy.

There are several things to keep in mind when considering whether a robo advisor is appropriate for you. They include the following:

Account Type

Many robo advisors are designed to manage both taxable accounts and individual management accounts (IRAs). You can also find a robo advisor that manages trusts and 401(k)s.

Portfolio Suggestions

The first thing you’ll normally encounter in your interaction with a robo advisor are questions that help the robo advisor determine your investing preferences, goals, and risk tolerance.

Then the robo advisor will recommend a portfolio based on your answers. You should be able to reject the suggested portfolio if you’d prefer another one.

Account Minimum

You should choose a robo advisor with minimum investment requirement that you can afford. Robo advisors have account minimums of below $500 up to over $50,000.

Retirement Plan

Your robo-advisor will normally recommend portfolios based on the time you expect to retire. If you plan to retire in five years, for example, the robo advisor will direct your retirement investing to a more conservative portfolio that leans largely toward bonds and cash.

Conversely, if you plan to retire in 30 years, your advisor may direct you toward a little bit aggressive portfolio composed of stocks. You may also be advised to have several accounts, each composed of a different portfolio.

Fund Selection

Robo advisors normally create their portfolios out of low-cost ETFs and index funds. These are a collection of investments that aim to reflect the behavior of an index.

When you invest in these funds, you’ll be required to pay the fees that they charge plus the management fee charged by the robo.

Final Thoughts on Robo Advisors

Robo advisors offer automated portfolio management services, including investment goal and risk screening, asset allocation, and portfolio screening, all with little or no human intervention. They are an excellent way to save time and reduce investment costs.