We already rely on robots and automated services when it comes to picking and delivering our shopping or online banking. The robots are now also taking over the investment world. Rather than images of the Terminator bursting into fund manager offices warning them to “invest with me if you want to live,” robo-advisors provide a low-cost and flexible alternative to traditional financial advice.
What is a robo-advisor?
A robo-advisor is an algorithm-driven investment advisory service that automates portfolio construction, monitoring and rebalancing, all with little-to-no human interaction. Like a human financial advisor, who will construct a portfolio on your behalf based on your investing goals and risk tolerance, a robo-advisor will construct a portfolio on your behalf based on your answers to a short questionnaire that gathers similar metrics: your financial goals, time frame and risk tolerance.
Automating this process and constructing portfolios of low-cost exchange-traded funds (ETFs) helps keep costs low. Whereas a human financial advisor may charge an advisory fee of around 1% of your total assets under management, most robo-advisors typically charge an advisory fee of 0.25%. Some brokers, like SoFi Invest and Titan, offer robo-advisory services at no additional cost.
The whole robo-advisory process is conducted online, from sign-up to portfolio construction to portfolio management. Here’s how it typically works:
Sign up for an account. Provide personal information such as your name, Social Security number, email and password, just as you would when signing up for a regular brokerage account.
Complete a short questionnaire. Answer questions about your investing goals, time frame and risk tolerance.
Confirm your suggested portfolio. The robo-advisor will recommend a portfolio, typically of ETFs, based on your responses from the questionnaire. Review your options and choose a portfolio.
Fund your account. Connect a bank account or transfer assets from another broker to fund your new robo-advisor account.
Periodically monitor your account. The robo-advisor will provide general portfolio management like rebalancing, but you should check in on your account every so often to ensure your investments still align with your goals and risk tolerance.
The first step when choosing a robo-advisor is to ensure it is regulated. In the US, robo-advisors should be SEC-registered investment advisers.
From here, consider the following:
Cost. Most robo-advisors charge an advisory fee of around 0.25%, while others like Acorns, charge a flat monthly fee. If you’re looking to invest a very small amount, such as $50 per month, flat-fee platforms can turn out to be more expensive. Also consider miscellaneous fees like account transfer fees or paper trade confirmation fees.
Past performance. Check how well a platform’s portfolios have performed. Most will let you see the track record of their risk rated funds over time periods such as 1, 5 or 10 years. Remember, past performance isn’t necessarily an indication of how a portfolio will fare in the future but it can give you an indication of what to expect.
Features. Robo-advisors will let you monitor the performance of your portfolio online. But some may offer extras such as an app or tools to forecast how much your pot could be worth in the future based on your current level of investment.
Customer feedback. Check customer reviews and see if others have a generally positive experience with the robo-advisor.
Investment options. Does the robo-advisor only offer ETFs, or does it let you invest in individual stocks or mutual funds too?
Account types. Is the robo-advisor only available through a taxable brokerage account or can you automate your retirement savings?
There is usually no charge to open an account with a robo-advisor, but most will charge advisory fees once you start investing. You will usually need a minimum amount to start an account and there may be a certain amount you have to contribute each month.
Common robo-advisor features
Risk questionnaires. You will need to answer a series of questions that assess your risk appetite and how comfortable you are with different styles of investing and levels of loss.
Model portfolios. Robo-advisors offer portfolios of tracker funds or exchange-traded funds that give you exposure to different markets. They are weighted based on different risk levels with the most cautious following developed markets and the more risky putting money into emerging market economies.
Email updates. Rather than regular meetings with a financial adviser, robo-advisors will offer blogs, email updates and videos. These will often explain the performance of the portfolios and any changes in strategy or outlook.
Website and app features. You will be able to log in to your account and track your portfolio’s progress through an app or website. You can also make withdrawals and increase or decrease your investment online from your smartphone or computer and use graphs and tools to forecast what your portfolio could be worth in the future.
What is a ready made portfolio?
Rather than investors choosing their own funds, a ready made portfolio is prepared for them. Thus combines a range of investments, which are mainly passive funds in the case of robo-advisors.
The type of funds will depend on the risk rating of the ready made portfolio. Riskier portfolios will hold assets that can have the potential for higher returns such as emerging or alternative markets but also for steep losses.
All the monitoring and rebalancing is managed for you so you just have to decide how much risk you are willing to take and how much money you want to invest.
Do you need a robo-advisor or financial adviser?
A robo-advisor or financial advisor may be worth it if you want to take the hassle out of researching and monitoring an investment portfolio. The robo-advisor will construct, monitor and rebalance your portfolio automatically and for a lower cost.
On the other hand, a human financial advisor can help with wider financial planning issues beyond just investment selection and monitoring and can ensure you are investing the correct amount in the most appropriate way. An adviser can also be at the end of the phone if you have worries about your portfolio, which isn’t possible with all robo-advisors. Using a human financial adviser can also be beneficial if you have more complex financial planning needs such as inheritance tax planning or you are working out how and when to access your pension.
Some robo-advisors may also provide financial advice and a review of your financial goals and portfolio for an extra fee.
Can you trust robo-advisors?
Yes, you can typically trust robo-advisors. Like human financial advisers, robo-advisors must be SEC-regulated and many employ various safety measures to ensure customer information and money is safe and secure.
Pros and cons of robo-advisors
Pros
Set up an account in minutes
Low cost investment
Monitor performance online
Ready made portfolios are set up and managed for you
Cons
May not be suitable for complex financial planning needs
No guarantee that your responses reflect what is the most suitable product for you
Little control over where your money is invested
Need to be tech savvy
Bottom line
A robo-advisor provides an effective middle ground between those who aren’t confident about managing their own investments and don’t want to or don’t have enough money to use a financial adviser.
Everything is set up and managed for you online within minutes based on your responses to a risk questionnaire.
This approach can be faster than using a financial adviser and you get access to snazzy websites and apps.
But it isn’t an overall financial planning experience that a human adviser can provide, which may be more beneficial for those with more complex needs.
Frequently asked questions
Robo-advisors have to be approved and regulated by the Financial Conduct Authority (FCA).
This means, like banks, investment firms and other financial advisers have to follow rules on treating customers fairly, keeping client money safe and running a prudent business.
Returns vary across providers. Most will have a statistics page where you can track the performance of the various portfolios on offer from a robo-advisor. You can usually see how portfolios have performed over 1 or 5 years or even by individual time periods.
It can be hard to compare providers directly against each other as their risk rated portfolios may have different assets but it is useful to contrast how they all perform in different markets to spot the best robo-advisors.
Past performance isn't a guarantee of future returns but it does give you a sense of what could happen with your money.
An index fund follows the performance of an index such as the FTSE 100 or S&P 500. It is made up of companies in the index it is tracking and will closely replicate their performance. This means if an index goes up, so will the tracker fund. But it also works the other way and a dip in an index will also be reflected in the performance of a tracker.
In contrast, a robo-advisor builds a diversified portfolio of different ETFs, some of which may be index funds, based on an individual's attitude and appetite for risk.
Robo-advisors are still regulated in the UK but they provide a different type of support than financial advisers.
They offer a simplified form of advice geared towards recommending funds based on your response to a risk questionnaire. That is different to a financial adviser, which is regulated and qualified to advise on a range of issues and may be able to recommend a wider range of products.
The robo element of robo advice refers to the algorithms behind the risk questionnaires and the technology that helps users contribute to and monitor their portfolio online.
There is still plenty of human interaction behind the scenes at a robo platform such as building and rebalancing portfolios and setting investment strategies based on their economic and political outlook.
Marc is an award-winning freelance journalist specialising in business and personal finance. His work has appeared in print and online publications ranging from FT Business to The Times, Mail on Sunday and Business Insider. He also co-presents the In For A Penny financial planning podcast.
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