What is a Robo-Advisor?

Franklin Silva| Updated January 13th, 2022

Nowadays, in the US, it is very common for retail investors to invest their money through Robo-advisors. Because of its popularity, now there are Robo-advisor startups appearing in most countries throughout the world. Want to know what are Robo-advisors, their pros and cons, and if we recommend them? We’ve got you covered!

What exactly is a Robo-Advisor?

Robo-advisors are basically wealth management firms that allow you to easily open an investment account and choose an appropriate portfolio online without speaking to a human. Because this process is automated and powered by technology, their fees tend to be very low when compared to most mutual funds and financial advisement firms.
Robo-advisors’ objective is to build an optimal and diversified portfolio for each investor profile. Also, it is their function to manage your investments over time – most Robo-advisors nowadays include services like automatic portfolio rebalancing and tax-loss harvesting.

How do Robo-Advisors work?

Robo-advisors will start by asking you some questions, like your objectives, age, risk tolerance questionnaire, etc. Then, you are normally recommended an optimal portfolio in which the Robo will invest for you, according to your profile and objectives. Some Robo-advisors allow you to personalize the portfolios according to your preference, others won’t. All of this is completely automated and with the use of pre-defined algorithms.

Then, over time, the Robo-advisor will adapt and manage your portfolio, periodically rebalancing your portfolio (generally on a monthly basis) – imagine that a portion of your portfolio (example, US equity) has increased a lot in value, then what the Robo-advisor will do in the future is rebalance your portfolio to make it optimal, using dividend payments and additional contributions.

What are the fees charged by a Robo-Advisor?

The fees charged by each Robo-advisor vary a lot, but you should expect to pay a 0.2%-1% annual management fee, depending on the Robo-advisor and the account type.

In some platforms, you, also pay the regular underlying investment products’ fees, such as spreads on ETFs, and these can be as low as 0,2% per year.

Comparing it with traditional advisors and mutual funds, who can charge 2-3% annual fees, Robo-advisors’ are much more affordable.

What are the alternatives to a Robo-Advisor?

As an investor looking to act in the stock market, you can either:

  • Do-it-yourself – you open an account in a brokerage and autonomously make and manage your own investments. This requires time and education in the financial markets.
  • Work with a traditional advisor – normally, you go to a bank, who will assign you a financial advisor. Then, this professional will make you some questions, study your profile, and finally propose an investment portfolio. This service is very personalized, however, you will normally pay high fees (about 2-3% a year) and unless you have, let’s say, 100 thousand dollars/euros to invest, it doesn’t make much sense to have a financial advisor.

Who are Robo-Advisors recommended to?

Robo-advisors are recommended for small, long-term investors, who:

  • Don’t know their profile;
  • Don’t want to study investments;
  • Don’t want to spend time managing their investments.

Robo-advisors can be a good option for investors who don’t want to participate in decision making and who don’t have a philosophy of investment. But who prefer to delegate, at a low cost, with no fixed or upfront costs, and no minimum deposits, as you have in traditional advisors.

This way, a small uneducated investor can also benefit from proven stock market strategies that were traditionally reserved for wealthy individuals, but at a fraction of those traditional costs.

Who are Robo-Advisors NOT recommended to?

Many investors value the personal relationship and more personalized service, be it because they have big bankrolls to invest, specific situations like tax-optimization or inheritance-planning or because they are just not comfortable investing without the recommendation of a real professional who understands the financial markets. In these cases, Robo-advisors are not recommended and you will probably be better off paying additional fees for a full wealth management service.

On the other side, are investors looking to build their own portfolios, either because they believe they can get a better risk/return, or because they do not want to pay any additional fees to the Robo advisors’ services.

Is it safe to invest through a Robo-Advisor?

Most Robo-advisors will invest on your behalf, meaning that the assets will always be registered in your name. Thus, even if the Robo breaks, your investments should be protected. Also, these companies are normally regulated by competent authorities that will provide protection of your investments up to a certain amount. Make sure to make your own research before investing in any of these platforms.

What are Robo-Advisors’ pros and cons?

Pros

  • Very easy to start investing
  • Optimize your investments
  • Automatic rebalancing
  • Tax-loss harvesting
  • Access to advice, if needed
  • Passive investment
  • Low fees when compared to traditional advisors or mutual funds
  • Available for anyone, regardless of the size of your bankroll

Cons

  • Some may consider it too much passive – many times called the “fast-food” of investments
  • Lack of published returns in most platforms
  • Less likely to learn about investments
  • Management fees
  • Still recent in the market

What’s the best Robo-Advisor?

There are many different Robo-advisors out there and it is complicated to decide which is a better option for you. When comparing Robo-advisors, here are a couple of things you should look at:

  • The investment strategy – where and how they will invest your money. Most Robo advisors are partners of a specific broker, and you should carefully investigate if they are not “pushing” their own investment products, often with high fees. Make sure they are an independent, low-cost, and transparent investment service.
  • Available countries – are they available in your country?
  • The returns of the current users;
  • Minimum deposit;
  • Fees charged;
  • Personalization of your portfolio;
  • Liquidity – how long does it take to withdraw money? Will there be any additional charges?
  • Auto rebalancing;
  • Tax-loss selling;
  • Advisor access;

At Investing in the Web, we have reviewed a number of the Robo-advisors operating in Europe.