Robo Advisors Definition Examples How They Work

Robo -Advisors Definition

Explanation

Robo-Advisors operate digitally and provide automated financial advice to clients catering to investment management, portfolio managementPortfolio ManagementPortfolio management involves overseeing a set of investments, including securities, bonds, exchange-traded funds, mutual funds, cryptocurrencies, etc., on a personal or professional levelread more, estate, and retirement planning, etc. They collect data concerning clients’ preferences, financial conditions, and desired return expectations and then run algorithms to allocate and manage clients’ assets.

Robo-Advisors were launched officially during the global financial crisisFinancial CrisisThe term “financial crisis” refers to a situation in which the market’s key financial assets experience a sharp decline in market value over a relatively short period of time, or when leading businesses are unable to pay their enormous debt, or when financing institutions face a liquidity crunch and are unable to return money to depositors, all of which cause panic in the capital markets and among investors.read more in 2008 when they were made publically available. The technology has been in use by financial advisors and managers since the early 2000s. Such advisors from around 100 companies globally were managing clients’ assets to the tune of $60 billion by the end of the year 2015. Assets under management have been estimated to reach $2 trillion by the end of the year 2020.

Features

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Digital Platform – Provide a digital platform that can be used by the investors as per their convenience at any time of the day.Algorithmic Techniques – Robo-advisors deploy mathematical and algorithmic techniques to arrive at a decision for their clients.Little Human Supervision – They work without or with limited human intervention; hence they are independent of any human biases involved in investment decision making.

Examples of Robo-Advisors

Below are some examples –

Example #1

Wealthfront is a California based automated investment company. It is a Robo-advisor offering assistance in the planning of one’s goals, transparency in building one’s portfolio, and various account services. It has reported assets under management of around $20 billion as of September 2019.

Example #2

Betterment is a New-York based online investment company. It is one of the best Robo-advisors in the industry, known for its standard for service. It has reported assets under management of around $16 billion as of April 2019.

Hiring Robo-Advisors

Hiring a Robo-advisor will entail evaluating one’s financial situation/ condition, time horizon, investment objectives. They provide a digital platform giving online ease of access. The millennials and current generation prefer a smooth online interface for catering to their financial needs and investments, saving their time, efforts, and money. Hence, the concept has kicked off pretty well recently and is being deployed by a lot of people for their investment and portfolio management.

How to Select a Robo-Advisor?

Understand your goals and facilitate goals planningUnderstand the fees structure and a minimum investment of the advisorsKnow the credentials of the advisor organizationCheck the interface of the platform and ease and transparency of accessAlign your goals with that of the advisors’ offeringsKnow when they might not be right and what decision should be made at that point.

Robo-Advisors Fees

Most Robo-advisors charge management fees of a certain percentage of total client’s assets, annually. Usually, their fees are generally less than those charged by human advisors. Many have minimum balance requirements, account opening fees, and some other kinds of fees too. It is always better to compare the fee structure of all the advisors which one is considering before selecting the final one.

For Example, Betterment has no minimum balance requirement. It charges 0.25% fees on assets under management annually.

Wealthfront and Charles Schwab are two of the most economical Robo-advisors based in the USA.

Who Should Consider Robo-Advisors?

Robo-advisors offer accounts largely composed of low-cost index mutual fundsMutual FundsA mutual fund is a professionally managed investment product in which a pool of money from a group of investors is invested across assets such as equities, bonds, etcread more and exchange-traded fundsExchange-traded FundsAn exchange-traded fund (ETF) is a security that contains many types of securities such as bonds, stocks, commodities, and so on, and that trades on the exchange like a stock, with the price fluctuating many times throughout the day when the exchange-traded fund is bought and sold on the exchange.read more (ETFs). Many, in fact, provide access to live financial advisors whenever needed.

The people who wish to invest in markets and plan their finances but don’t have the time to research every fund and investment avenues should consider such advisors.

Beginners can look at investing in low-cost, broad-market index funds. As one gets older, and their investment strategyInvestment StrategyInvestment strategies assist investors in determining where and how to invest based on their expected return, risk appetite, corpus amount, holding period, retirement age, industry of choice, and so on.read more becomes more sophisticated, they might want more options and flexibility than a Robo-advisor can deliver.

If someone has been hesitant to invest because they don’t know how to get started, Robo-advisors can offer clarity, as well as the push they need to actually get in the market.

Benefits

Robo-Advisors have been the link between the financial services world and an average person wanting to get into investing. They have made the sound financial planningFinancial PlanningFinancial planning is a structured approach to understanding your current and future financial goals and then taking the necessary measures to accomplish them. Because this does not begin and end in a specific time frame, it is referred to as an ongoing process.read more accessible to all and not just High Net-Worth Individuals.

Low Cost – These advisors offer low-cost services as compared to traditional financial advisors. Since human supervision is not involved or is limited, the online platform can offer services at a fraction of the cost that would have to be incurred with human resources.Accessible – These advisors are usually more accessible in contrast to human advisors, providing a platform that could be used 24*7 throughout the year.Efficiency – Online Robo-advisors are more efficient since it doesn’t require meeting and discussing with a human advisor, explaining objectives, filing paperwork, etc.

Limitations

Extraordinary Situations – Robo-advisors are not very well equipped to provide rational decisions in case of exigencies and anomalies in the market. The algorithm might fail to provide optimal decisions in case of extraordinary situations and crisis-like conditions.Lack of Subjectivity – They can’t handle the subjectivity involved in making decisions to the clients, which a human advisor can understand and accordingly consider into his/ her decision.Sophisticated Products – They have been able to establish themselves in low-cost index-based products; however, they won’t be able to replace the need for human involvement, which is required in the case of sophisticated and structured productsStructured ProductsStructured products in Finance refer to a set of two or more assets or securities with a combination of an interest rate and single or multiple derivatives. These pre-packaged investments may include traditional financial instruments, such as equities, options, investment-grade bonds, indices, commodities, mutual funds, exchange-traded funds, or currency pairs, with non-traditional payoffs.read more.

Conclusion

Robo-Advisors are playing an important part in the financial services industry across the globe, replacing human intervention in planning the finances, managing investment, and planning for retirement to a certain extent. They have grown their assets under management over the years and are expected to scale up to more in the upcoming years. They might not be able to replace human financial advisors in entirety, but they will penetrate various dimensions of the financial services industry and will help in achieving efficiency across the industry.