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What Is A Robo-Advisor? Defined & Explained

Written by JD Esajian

Robo advisors are a type of online service that is meant to help people plan financial goals. In some cases, it also provides them with ways to invest at a low cost with no account minimums.

Planning investments, especially as a beginner, can be overwhelming and confusing. This is where Robo advisors come into play. They can manage all your investments and your portfolio without you needing to do all the mundane tasks that come with investment and financial planning.

Robo advisors are quickly gaining popularity as more and more people are looking for ways to automate their lives. So what is a Robo-advisor?

What Are Robo-Advisors?

You might hear Robo advisors being called automated investing services. They use special software and computer algorithms to help manage investment portfolios. Usually, there is no human interaction, but some Robo advisors also have human advisors that you can contact and speak with when you need some help with problems.

You will fill out a questionnaire when you make your account that allows the Robo advisor to learn who you are as an investor. They can design inputs for you based on your portfolio.


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robo advisor

What Services Do Robo-Advisors Provide?

For many advisors, the formula is the same: automate investment management so that a computer can do it more cheaply. The majority of Robo-advisors offer:

  • Portfolio rebalancing on a routine basis, either autonomously or at predetermined intervals, such as quarterly. The majority of advisors use computer algorithms to accomplish this, ensuring that your portfolio never deviates from its initial allocation.

  • Instruments for financial planning, like retirement calculators.

  • Taxable accounts that offer tax-loss harvesting and other tax-strategies.

Online financial planning services may appeal more to you if you want or need more thorough financial planning or if you’re apprehensive about trusting a computer with your portfolio.

How Do Robo-Advisors Work?

Robo advisors are able to gain information about you and put it to use with algorithms. This allows them to predict investor goals and determine what risks and preferences you might have.

The algorithm is formed by the profile and questionnaire you create for yourself. They can also understand your financial behavior when seeing your bank and credit card transactions.

Experts will also monitor your bank and market activity. This allows them to rebalance your investments according to your goals and behavior to ensure you never get too far off track.

Suppose your Robo advisor provides access to financial advisors and certified financial planners. In that case, they can also prioritize your goals and give recommendations based on how they think you would behave in certain financial situations.

Benefits of Robo-Advisors

There are many benefits to Robo advisors, including:

  • Comprehensive services: Robo advisor platforms offer many services to help you plan your financial future, including retirement planning and tax strategy optimization. Robo advisors can look at your portfolio, manage your finances, and align your investment goals.

  • Free of human bias: If you use a human advisor, they might have a bias towards certain goals or companies that could influence how you invest your money. Robo advisors do not have this kind of bias or influence. They only rely on algorithms to evaluate risks and decisions for you.

  • Easy access: Robo advisors can be accessed anywhere with an internet connection. You don’t have to wait for your financial advisor to make an appointment. Since they are easily accessible, wealth management can also be more accessible to a large number of people rather than just those who can afford to meet a financial planner.

  • Tracking of your investment priorities: As the Robo advisor looks at your investment goals based on your profile, they can determine your financial priorities and responsibilities. Sometimes the Robo advisor is even better at determining goals than you might be yourself. The Robo advisor can also ensure you are always going after your goals and staying on track to reach them.

Robo-Advisor Limitations

As with any new technology, there are some limitations when it comes to Robo advisors. Sometimes, the lack of human interaction can do more harm than good. Older generations also usually do not want to use online technology and would rather talk to a human that can give them advice.

Some high-net individuals would also rather seek advice from a trained financial planner rather than rely on online software.

Some Robo advisors are also overly simplified and might not catch all the same details as a human advisor.

what are robo advisors

Types Of Robo-Advisors

There are a few different types of Robo advisors that you should know about. Knowing the differences will allow you to better understand which one you might be working with so you can understand conflicts of interest and how they gather information about you.

Technical Competency

The first is technical competency. They are then further divided into two categories called simplistic and comprehensive.

When using a simplistic advisor, potential investors will have a brief questionnaire to fill out the information about themselves to help the Robo advisor know their risk assessment and investment strategies.

Comprehensive advisors will do even more, and they can better predict behavior by using artificial intelligence data. The AI technology will be able to tell the Robo advisor many different things about you, including net worth, current liabilities, and spending patterns.

Revenue Stream

Revenue stream is the other kind of Robo advisor. Some Robo advisors earn income through the commission of the manufacturer for the product they work for, while others might charge a fee from the investor.

Robos that earn their income from a certain company are said to be biased because they might allow this revenue to affect their recommendations. If the Robo charges an advisory fee, you will be the one in charge of paying it directly, but there will be no conflict of interest.

Scope

The last type of Robo advisor is the scope. These are divided in different ways for the scope of their functioning. Robos can offer advice on many different financial products and assets.

What Do Robo-Advisors Cost?

If you are considering using a Robo advisor, one of your main questions might be how much they cost so you can factor it into your monthly budget. In general, Robo advisors are much cheaper than human financial advisors.

Most companies typically charge an annual management fee between 0.25% and 0.50%. Some Robo advisor options don’t have management fees. Fees are usually a percentage of your assets that the Robo advisor oversees.

Most of the fees are automatically taken out of your account and can be charged monthly or quarterly. Robo advisors do not usually charge transaction fees. However, with human advisors, you might have to pay a commission when you sell investments since it means your portfolio will need to be rebalanced.

Robo advisors will waive these charges so you can save money.

Robo-Advisors Vs. Online Planning Services

Online planning services work a little differently because they are a mix between Robo advisors and traditional advisors. You usually have access to financial planners, but you won’t meet them in person, and everything is done electronically through phone calls or video conferences.

So, you can still meet with a human financial advisor for a lower cost than what you would typically pay when meeting with a traditional financial planner. However, the more human involvement you have through the platform, the more you will pay. Certified financial advisors and planners also charge more since they have more education and certification.

Since these services are a kind of hybrid, they are usually a good option for those who do not want to make decisions without speaking to a real person. Some investors need human interaction. Hybrid systems are a good way of getting the best of both worlds. You can still operate online, but you will have humans when you need them for a fraction of the cost.

Is A Robo-Advisor Worth It?

Here are some things to consider when deciding if a Robo advisor is right for you:

  • Investment selection: Most Robo advisors will make a plan for you based on low-cost exchange-traded funds and index finds. You will have to pay the fees for these funds.

  • Minimum investment requirements: You need to be able to make the minimum investment, whether it’s $500 or $5,000.

  • Type of account: Typically, you can have retirement accounts and taxable accounts. Depending on the profile, you might also be able to get help managing your 401k.

  • Portfolio recommendation: Robo advisors will usually make recommendations based on your questionnaire. Then, you will be offered between 5 to 10 portfolio choices which range from very aggressive to more conservative. You can choose which end you want to be on or stay somewhere in the middle. The Robo will make a recommendation for you based on your answers, but you always have the choice to turn down the recommendation and pick whatever portfolio you want.

Whether a Robo advisor is suitable for you or not depends on your own motivations. If you want a low-cost way to manage your investments, Robo advisors might be a good choice. If you want personal discussions and human interaction, you might want to meet with a financial planner or choose a hybrid approach, so the Robo is not making all the decisions for you.

Robos are well worth the price for many since they offer a large range of management services. The small monthly fee is much less than you would pay a human financial advisor.

Summary

Many people that are unfamiliar with the most technologically-advanced investing strategies are asking, “what is a robo-advisor?” Hopefully, this guide answered all the questions you might have had about Robo advisors, what they do, and what they are. Robo advisors are one of the top ways to manage your investments and finances, whether you are a beginner or more experienced. Hybrid options are also available if you want to have more human interaction but still keep the majority of your portfolio solely online.


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