What Are Robo-Advisors?

FT Contributor  | 

A robo-advisor is a new type of online financial advising software that can help you manage your investments. Typically, robo-advisors are only used by individuals who have assets to manage but not enough investments to require the assistance of a financial advisor. A robo-advisor is a good option if you’ve typically managed your assets yourself, but you’re now ready to hand over the job of selecting investments, rebalancing your portfolio, or placing trades to an automated service.

Robo-investing has become a popular option because it’s an easy way to build a diversified portfolio and is associated with lower fees than personal financial advisors. Some of these online platforms automatically make changes to your portfolio to ensure it’s balanced, eliminating the task of analyzing the market or deciding whether to trust your financial advisor’s opinion on the future of your investments.

How Do Robo-Advisors Work?

Robo-advisors were designed to manage funds and investments passively. While automated portfolio allocation similar to robo-advisors has been around for some time, it’s only been directly accessible by wealth managers. The latest robo-advisor technology interacts directly with investors to help them successfully:

  • Buy and hold investments.
  • Optimize portfolios.
  • Make trades.
  • Rebalance or diversify portfolios.

A robo-advisor may ask you to first complete a financial survey and provide information on your current portfolio and investments, as well as grant access to your funds and accounts. It can then begin to automatically make moves for you as it sees fit through its formulas and calculations.

Types of Robo-Advisors

There are generally two different categories of robo-advisors currently available. Your personal investment strategy and financial situation will determine which type of robo- advisor works best for you.

Passive Robo-Advisor

A passive robo-advisor is the most common type because it’s fully automated and doesn’t include working with a human financial advisor at all. With passive investing, the robo advisor buys and holds a broadly diversified portfolio. The software typically doesn’t make many changes to this portfolio and allows it time to make a profit. The goal is to match whole market gains over time instead of trying to beat the market.

This type of robo-advisor is best if you’re interested in long-term investing. It can take a while to see growth with a passive investment strategy, so this type of software should only be used if you’re not looking to make a profit for years and have patience with your portfolio. Since this type of investing doesn’t require rapid buying and selling, a robo-advisor is helpful for managing the portfolio without having to make constant investment decisions.

Hybrid Robo-Advisor

A hybrid robo-advisor combines robo-advising with human financial advisor services. You’re responsible for providing your information online, including your current investments and financial goals. When you agree to a service proposal, the robo- advisor takes over managing your investments and you can contact a human financial advisor to begin achieving other goals or to ask questions about your portfolio.

With a hybrid robo-advisor, software is still responsible for managing your portfolio but you can also have a financial advisor review your investments when you feel it’s needed. Not only does this strategy take advantage of automated software to ensure your investments are thriving, you also have access to a professional financial advisor so you can review your long-term strategy or goals and make sure you’re on the right track.

You’ll pay a higher fee for a hybrid robo-advisor, but this type of service may be right for you if you already have a small portfolio that can be passively managed but still want personal advice to achieve future financial goals. With both a robo-advisor and a human financial advisor, you can have your funds automatically managed passively but you can also obtain personal assistance from an advisor when you need it.

Robo-Advisor Pros and Cons

Robo-advisors are attractive to investors for a number of reasons. However, it’s important to understand both the advantages and disadvantages of using a robo-advisor to manage yours funds.

Advantages:

  • Robo-advisors charge lower fees than human financial advisors.
  • They offer passive management, so there isn’t much work needed from you.
  • The funds are automatically managed, so you can’t make emotional or irrational decisions that could negatively alter your investment outcome.
  • You don’t have to stress about your investments, since all decisions are automatically made and executed for you.
  • They eliminate human error because a financial advisor isn’t making decisions for you based on predictions.
  • Robo-advisors can work for you 24 hours a day, seven days a week.
  • There’s usually no minimum investable assets you must have in order to qualify for advising.
  • You don’t have to do the legwork of logging in and placing trades yourself or researching stocks and the market.

Disadvantages:

  • You won’t have access to a financial advisor to give you advice on your investments.
  • You may crave the flexibility of a human advisor, who can listen to your opinions and help you critically adjust your investments.
  • Robo-advisors don’t assist you with retirement planning accounts, such as a 401k or IRA.
  • You may not feel the robo-advisor has a firm grasp of your preferred investment strategy or financial goals.
  • You can’t choose which funds you invest in, since it’s automatically done for you.
  • You can’t pick or purchase individual stocks and bonds for your portfolio.

Where to Find a Robo-Advisor

Since robo-advising has become a popular and growing industry, there are a variety of robo-advisors available. Many large financial advising companies offer this software as an alternative to traditional human financial advising or they may offer hybrid robo- advising services.

All you need is a computer and your financial information to complete the initial survey requested by robo-advising software. A robo-advising proposal is provided and you can sign up for services online. The software begins to automatically manage the funds and portfolio you give it access to and you can check its progress through your online account with the company.

If you have a full understanding of your financial situation and don’t feel you need the assistance of a human financial advisor yet, a robo-advisor may be the right choice for passively managing, diversifying, and rebalancing your current portfolio.


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