If you are interested in optimizing your investing, a Robo-advisor might be the next tool to for you to check out for all your financial budgeting needs. You don’t need to have a high capital for portfolio management with a Robo-advisor. They are unbiased and focused on using data to benefit you, allowing you to invest quickly and efficiently. Let's check it out.
What Are Robo Advisors?
Robo advisors are a service providing instantaneous investing, employing a minimal amount of human intervention. Robo advisors are also commonly known by the terms of automated investing services and online advisors, and they use computer algorithms and advanced software that builds and manages your investment portfolio.
Robo advisors charge you with a nominal of usually up to 0.5%. (meaning $50/year for every $10,000 invested). Some robo-advisors even provide their services for free! There is also no transaction cost with a Robo advisor, and other charges are frequently waived.
How Do They Work?
Let’s go through the process of signing up for a Robo-advisor. Usually, when you sign up for a Roboadviser, you will be asked to fill out a questionnaire with basic information about yourself. These questions prioritize your investment timeline and figure out your risk levels. The questionnaire also talks about how much money you will have in savings as well.
Your answers are then run through a series of algorithms to help provide them with an asset allocation approach and also to build a portfolio of diversified investments that can help you to meet your goals. After the creation of your portfolio, the software works on rebalancing your portfolio to help ensure that it remains aligned with your targets and your goals. Many people go ahead and make small weekly contributions to their accounts as well to take advantage of dollar-cost averaging.
(photo from Barron's)
Are Robo Advisors The Right Choice?
While you may be reluctant to let a machine do all the trading work for you, technology has evolved considerably over the past years. There has been a rapid influx of digitalization and developments in AI and many stock traders invest in high-quality robots to execute their transactions in milliseconds.
Robo-advisors offer their clients multiple investment options; some advisors provide their clients with more than 10 choices to construct and design their portfolios. Clients can choose from conservative to aggressive portfolios depending on their needs and preferences. The service recommends you a portfolio based on your answers to the questionnaire, but you can also easily veto their suggestions if they don’t seem to be fit.
Most Robo-advisors build their portfolios through low-cost exchange funds (ETFs) and index funds. Both of these are “baskets” of investments aiming to mimic the behavior of an actual index. For example, an ETF or Index Fund may track the S&P500 Index, which holds the top 500 companies in the US. Note that you will end up paying the fees that are charged by these indexes called expense ratios in addition to the Robo advisor management fee.
(photo from TD Ameritrade)
Benefits Of Using Robo Advisors
Robo advisors have enjoyed a considerable amount of success since their initiation because they are affordable. Their affordability allows for newer and younger investors to take advantage of automated investing without huge amounts of capital.
Robo advisors eliminate human involvement, which means that they can provide services to their customers at a fraction of the cost. There are no hidden charges and a simple flat percentage fee towards the end of the year which doesn’t often exceed 0.5% of a person's account balance. (meaning $50/year for every $10,000 invested)
Robo advisors are available around the clock and don’t have opening or closing hours. It takes significantly less capital for them to get started as well. Human advisors tend to choose higher net-worth clients than robo-advisors to can earn more in fees and focus on creating a more in-depth strategy for large amounts of capital. You don’t need to have a large amount of capital with a Robo-advisor.
Robo-advisors are also significantly more efficient. You don’t need to visit or call someone and explain what you want to be done to your trades. With robo-advisors, all calculations, adjustments, and decisions are made quickly done with a click of a button from the comfort of your home!
Disadvantages Of Robo Advisors
They Lack Empathy
One department where Robo advisors fall short is empathy. They are unable to differentiate between right and wrong and also do not possess emotional intelligence. For example, while a human might not buy stocks of a company with practices that violate and exploit human rights or a company that engages in animal or human abuse; Robo-advisors will not be able to tell that difference. The robo-advisor will invest in companies for profit, where as a human advisor may sense the mood of the client and not execute certain trades.
In today’s world, investors are not only concerned with the stock price and profitability, but many investors look at the company's practices before making an investment.
If you are interested in socially responsible investing with a robo-advisor, check out the social investment portfolios from Betterment. They offer three investing portfolios.
Broad Impact: A low-fee, globally diversified portfolio designed to help you reach your goals while investing in ETFs that meet Environmental, Social, and Governance (ESG) requirements.
Climate Impact: With this option, you can invest in ETFs that support companies with lower carbon emissions and the funding of green projects. It also features ETFs that divest from holders of fossil-fuel reserves.
Social Impact: This offering is based on Broad Impact and adds two funds that support minority empowerment and gender diversity: Impact Shares’ NAACP Minority Empowerment ETF and State Street’s Gender Diversity ETF.
Feel free to check out these three portfolio’s here.
(photo from Betterment)
They Lack Sophistication
While robo-advisors do sound like the perfect deal, they do come short in one department and that is sophistication. Most robo-advisors are not equipped well enough to cater to the needs and the numerous wealth financing strategies of high net worth individuals. Many investors are also very reluctant towards this shift from a human advisor to a robotic advisor as most humans are usually intuitive and can understand their client's risk appetite and investment styles better. Robo-advisors take what you say at face value and this can become a problem with investors that are unsure of what strategy they want in their investment portfolio.
Robo-advisors, however, are an innovative solution for many people who were not able to invest previously. They are a competitive investment choice, and it's only a couple of years until they become one of the more commonly chosen options.