Robo-advisors have been existing for nearly a decade. Still, their popularity is skyrocketing. They are simply automated portfolio managers. In short, they act as an autopilot for investors around the globe. They offer special investment services and financial advice to young investors.
This introduction to using Robo-advisors comes in handy for anyone looking to understand this automated investment tool in more detail.
• What exactly are Robo advisors?
• How do they work?
• How to invest with them?
• Kinds of returns to expect?
• Types of Robo advisors
• How much they cost?
• How to choose a Robo-advisor?
• Pros and cons of using Robo-advisors?
That said, let’s get started.
What are Robo Advisors?
Robo advisors are digital platforms designed to help individuals save and invest their money towards a specific goal. They help in the management of users‘ investments without having to consult a financial advisor. Besides, they ensure you don’t go through all the troubles to self-manage your portfolio.
A wide range of financial institutions in the US such as Fidelity and Acorns provide these unique automated investment products. In Germany, there are many options (such as Whitebox) which will be covered in seperate reviews.
They are perfect alternatives for traditional financial advisors and usually an incredibly cheap option for many investors. Additionally, robo-advisors are a great alternative to an investor – they simply pick and select the investments themselves.
How do Robo advisors Work?
As a new client, I’ll first need to sign up for a robo-advisor. In this case, I will enter basic information about my investment goals and financial situation into an online questionnaire. Some of the questions may touch on my risk tolerance, investment timeline, current, and expected future income, expenses, and the amount of money I have in the savings account.
After that, the Robo-advisors will automatically process the answers via an algorithm and module to offer an efficient asset allocation style. Other than that, they’ll build a rich portfolio of varied investment plans that suits my goals.
Once my funds get invested, the software can automatically rebalance my portfolio to make sure that it works towards the target. Tons of famous robo-advisors inspire investors to contribute to their accounts more often, like making small deposits every week. By doing so, the robo-advisor will then use such contributions to uphold the target allocation.
What’s more, I can log into the system whenever I want to view my investments, account balance, and progress towards reaching my investment goals. Other than that, there’s nothing else to do. The robo advisors often have a different list of investment products they use to implement a savings plan effectively.
How to invest using a Roboadvisor
Typically, the chief objective of most automated investing companies is to provide the user a remarkable experience. Thus, creating a portfolio is super easy than a traditional investment company.
To get started, I must provide all the information the software requires to craft an investment plan. In this stage, it is critical to give accurate and complete details so that the roboadvisor will design an investment plan best for my needs.
If there are some investments already available, I can easily transfer them to the software. But, they must have been already included on the software’s listicle of investible assets. It is usually easier to sell assets on the platform and invest the proceeds than transferring them. However, this may lead to tax liabilities that need settling. There are specific platforms that can allow me to share assets I want and then sell them as part of a tax loss reaping plan.
What kinds of earnings/returns to expect from a Roboadvisor investment?
A roboadvisor often generates earnings mostly from passive investment products invested in. the earnings typically depend on what asset groups the portfolio is invested in. Most importantly, these portfolios can’t be expected to give excess earnings or alpha above their targets.
Most Robo-advisors are aligned with a theory that plenty of active managers underperform their benchmarks. Thus, investors need to focus on earning market returns (beta returns) at the lowest amount possible.
Take away points to note about earnings generated by Robo-advisors ever since they emerged:
• The returns are not yet tested and certified by a rigorous bear market
• They create their portfolios bearing in mind long-term investments
• Don’t expect market-beating earnings from this software
Robo advisor costs
Robo advisors charge management fees every year. Users are usually charged a percentage of their total assets. They can range from 0 to about 0.89%, with most of them dropping to between 0.25 and 0.3%. In certain situations, the costs may vary depending on the client’s account size.
Alternatively, the fees can be structured to be deducted on a pro-rata monthly basis. Here, the charges can be as little as 1EUR, about 0.15 to 0.5%. Interestingly, these fees are distinct from other costs related to the investment plan.
Pros and Cons of Using Robo advisors
Automated investing products have some obvious advantages as well as disadvantages and risks.
• Incredibly affordable with the extensive asset allocation model
• Provide handy services such as tax-loss harvesting & cash management
• They remove emotion and stress from the investing process
• Fast to use unlike traditional investing platforms
• Easy strategies that suit the user’s needs
• No investment knowledge is required
• Less personalized as there’s minimal human interaction
• It relies only on the information the user provides, even if it’s incorrect
• They tend to remain untested for long
• Few Robo-advisors provide capital guaranteed or downside protection funds
Tips on How to choose a Roboadvisor
- For beginners, look for platforms without minimum balance requirements.
- Consider software that gives access to financial planners or human advisors in case of complex issues.
- Decide whether or not you need free access to other investment products such as stock portfolio.
- Read reviews (start with my one on Whitebox) and educate on the platform pros and cons!