Robo-advisors or automated advisors have stormed onto the investment scene as a way for all investors to participate in the wealth-building possibilities of the markets. No longer do you need deep pockets to hire a financial advisor or to invest in a professionally managed portfolio. From Betterment to Schwab or M1 Finance, the choices are vast.
A robo-advisor is an investment manager that uses computer programs to professionally invest your money. Beyond that, there are many varieties, with diverse fees, investment minimums, and features.
If you’re interested in a low-cost, professionally managed investment approach, then this development might be for you.
How it works
Synthesizing algorithms has been the backbone of successful programs in various fields. Waze and Uber are known for their transportation algorithms and Google for its search engine algorithms.
An algorithm is a fancy word for the process that a computer uses to solve a problem. A robo-advisor’s computer algorithm is the steps the computer takes to create your investment portfolio.
Computerized algorithms are perfect for investors due to their inherent efficiency and cost-effectiveness. And, picking investments based upon the best-practices investing research can actually be done better by a computer than a human.
At first glance, this concept might seem doubtful and risky. After all, traditional investment management was grounded in meeting with a financial advisor, coordinating with a stockbroker, or even becoming your own financial manager. In contrast, most robo-advisors were founded on Nobel Prize winner Harry Markowitz’s Modern Portfolio Theory, which explains how to create diversified investment portfolios with the greatest returns for each risk level.
Robo-advisors are computerized financial advisors that excel in one thing: creating a diversified investment portfolio following sound computer algorithms based on well-recognized modern portfolio management strategies.
These automated advisors ask you your age and a few questions about risk, goals and your time horizon. Then the platform runs your choices through their algorithms. Next, you’re assigned a risk level ranging from conservative to aggressive.
Their investment portfolios are mostly divided by risk. So, based upon your risk level, from conservative through aggressive, you’re provided with a collection of investments, in specific proportions, that meet your criteria.
The investment portfolio
So, for example, a young, aggressive investor might receive a recommendation for 90 percent stock investments and 10 percent bonds. Each of the colors on the “recommended allocation” circle represents investments in various funds.
All robo-advisors have a list of preferred investment funds. These exchange-traded funds (ETFs) are typically low cost, diversified index funds. For example, some exchange-traded funds show that more conservative portfolios hold a larger percentage of bond funds and the aggressive portfolios are more stock fund-heavy.
Some of automated advisors invest your money in exchange-traded stock and bond funds, which can also include commodity, real estate and other types of ETFs as well. The list of investments offered within each company is a distinguishing feature of specific firms.
Small and mid-cap value stock funds and foreign emerging market bonds differentiate Betterment’s investments list from competitors. Other companies might not have the value offerings but might include U.S. and global real estate ETFs or commodity funds.
Automated advisors come in different categories giving clients a wide range of options. Currently, there are approximately 12 most popular ones. They differ regarding key features, free services provided, minimum investment amounts and more. Depending on your preferences, there are many varieties from which to choose.
All of these advisors rebalance your investments. That means if the proportions of your funds drift from your original choices, the service will buy and sell shares to return the portfolio to your preferred allocation. So, let’s say you start with a 60 percent stock and 40 percent bond asset allocation.
Assume that stocks increase in value, more than bonds and your portfolio percentages grow to 70 percent stocks and 30 percent bonds. The platform will sell some stocks and buy more bond funds to return to your pre-decided 60 percent stock – 40 percent bond mix.
Tax loss harvesting
Many robo-advisors sell losing investments and replace them with others, to offset gains and reduce your tax bill. This is called tax loss harvesting and is a strategy for taxable investment accounts.
Human financial advisors
Some advisors provide users with access to financial advisors for investment-related questions. There’s usually an additional fee for this service, although not always. For instance, Betterment allows users to text with automated advisors for its 0.25 percent management fee and to speak with certified financial planners for their Premium Plan that costs .40 percent of assets under management. Wealthsimple includes financial advisors in their basic .50 percent management fee. For accounts over $100,000, the management fee drops to .40 percent.
From Ellevest, designed for women investors to M1 Finance, the free automated advisor with thousands of investment options, there’s a wide range of choices. Meanwhile, Blooom only manages your 401(k) investments. You pay $10 per month and Blooom chooses the lowest cost funds from the available choices.
Qplum is more hedge-fund-like: their fees are lower than those of typical hedge funds and you don’t need a six-figure portfolio to invest.
If you’re interested in socially conscious investing, there are several choices that offer impact investing portfolios: Betterment, M1 Finance, Grow App and Wealthsimple.
Robo-advisor fees are typically lower than stand-alone financial advisors, and that’s part of their allure. Advisory management fees start with free platforms at Schwab Intelligent Portfolios and Wisebanyan. After that, they range from .15 percent of assets under management on up to approximately .87 percent. Ones with higher fees typically offer more features.
The investment minimums also vary from zero at WiseBanyan to $50,000 at Vanguard Personal Advisor Services.
Is it for me?
If you are seeking low-cost, research supported investment management, then a robo-advisor makes sense. Even if you’re a DIY investor, there’s little reason not to investigate the free ones available.
You’ve learned that automated advisors have both similarities and distinctions. Yet, if you’re seeking a low-cost alternative to a traditional high fee financial advisor, then a robo-advisor provides an alternative.
(Featured image via Andrey_Popov via Shutterstock)
DISCLAIMER: This article expresses my own ideas and opinions. Any information I have shared are from sources that I believe to be reliable and accurate. I did not receive any financial compensation for writing this post, nor do I own any shares in any company I’ve mentioned. I encourage any reader to do their own diligent research first before making any investment decisions.
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