Table of Contents
What is a Robo-Advisor?
A Robo-Advisor is an online platform that uses algorithms to manage your investments automatically while helping you reach your financial goals. It’s financial advice that comes from an algorithm—in other words, a computer program—instead of a person.
Robo-advisors combine your information with its programming technology to create your personalized investing strategy. When a robo-advisor works 24/7 to manage your portfolio, it automatically adjusts your investments to current market conditions. It can review and rebalance your allocation of assets (stocks, bonds, and cash) in response to your specific investment goals and timelines.
How Do Robo-Advisors Work?
Robo-advisors ask new users to fill out a short questionnaire when setting up their account, and based on those answers, automatically select investments using an algorithm. The questionnaire will typically ask for your age, risk tolerance, and how long you plan to work before retirement, as well as gauge how you might react to the ups and downs of the stock market. All these data points are used to determine your portfolio’s asset allocation, which typically includes a combination of stocks, bonds, and uninvested cash that will still earn a fixed return.
From there, the robo-advisor will select and manage your investments with periodic adjustments to your portfolio over time, which generally includes rebalancing the portfolio and tax-loss harvesting. This process will take place automatically, with little to no action required on your part.
Choosing the Right Robo-Advisor
- Fees: Look at the robo-advisor’s fee structure. This could include management fees, trading fees, and other charges.
- Investment Options: Does the robo-advisor offer the types of investments you’re interested in?
- Customer Service: Check the robo-advisor’s customer service reputation. Can you easily get help when you need it?
- Account Types: Does the robo-advisor offer the type of account you want (e.g., individual, joint, IRA, etc.)?
Investment Action they Performs
Robo-Advisors perform a variety of investment actions and functions:
Automated Investing and Trading: Robo-advisors use algorithms to automate investing and trading strategies at reduced costs.
Portfolio Rebalancing: They can automatically rebalance your portfolio to maintain your initial portfolio allocation over time.
Tax-Loss Harvesting: Some robo-advisors can handle more sophisticated tasks like tax-loss harvesting, which involves selling securities that have experienced a loss to offset taxes on both gains and income.
Investment Selection: Robo-advisors provide a convenient and user-friendly interface, allowing investors to monitor their investments, make adjustments, and access financial planning tools.
Retirement Planning: Some robo-advisors also offer retirement planning services.
Account Activity Updates: Robo-advisors keep you updated on your account activity.
Reducing Costs of Frequent Transactions: Most robo-advisors are designed to follow Modern Portfolio Theory, balancing risk with reward. One of their greatest advantages is that they can perform all of these functions at a very economical cost.
Pros of Robo-Advisors
- Low Management Fees: Robo-advisors typically charge lower management fees than traditional financial advisors.
- Low Account Minimums: Many robo-advisors have low or no account minimums, making them accessible to a wide range of investors.
- Automated Investment Management and Monitoring: Robo-advisors use algorithms to automatically manage and monitor your investment portfolio.
- Unbiased, Proven Investment Strategies: Robo-advisors use proven investment strategies and are not influenced by emotions or biases.
Cons of Robo-Advisors
- Limited Personalization: While robo-advisors do offer some level of personalization, they may not be able to cater to more complex financial situations.
- Limited Flexibility: Robo-advisors typically offer a limited number of investment options.
- No Human Contact: While some robo-advisors offer access to human advisors, many operate solely online.
- Can Be More Costly Than Doing it Yourself: While robo-advisors are cheaper than human advisors, they can be more expensive than managing your investments yourself.
Conclusion
Robo-advisors can be a great tool for investors looking for a low-cost, automated investment solution. However, like all investment strategies, they come with risks and it’s important to understand these risks before investing. Always do your own research or consult with a financial advisor to ensure that any investment aligns with your financial goals and risk tolerance.
Remember, it’s important to do your own research and consider seeking advice from a qualified financial advisor before making any investment decisions. For more detailed information on Robo-Advisors, you can visit the FINRA’s page on Robo-Advisors.
Frequently Asked Questions on Robo-Advisor
A Robo-Advisor is an online platform that uses algorithms to manage your investments automatically while helping you reach your financial goals.
Robo-advisors use data from a questionnaire you fill out to understand your current finances, financial goals, and risk tolerance. Based on this data, it offers advice and automatically invests for you.
Yes, Robo-Advisors can be a good option for beginners as they provide a simple and low-cost way to start investing. They handle all the investment decisions and management, making it easy for beginners to get started.
The cost of a Robo-Advisor can vary depending on the provider. Some charge a percentage of the assets they manage for you, while others charge a flat monthly fee. The fees are typically lower than those charged by traditional financial advisors.
A Robo-Advisor can be a good option if you prefer a hands-off approach to investing, if you have a simple financial situation, or if you’re just starting out and have a smaller portfolio.
Yes, some investors may benefit from using both a Robo-Advisor for basic investment management and a human advisor for more complex financial planning needs.
Certainly. Just like any investment, using a robo-advisor comes with the risk of losing money. The markets can be unpredictable, and all forms of investing carry the potential for losses.
Being cautious with your money is wise, and surprisingly, a robo-advisor can be as safe as a human financial advisor. However, it’s important to remember that all investing carries the risk of potential losses, whether you’re doing it independently, consulting a financial advisor, or utilizing a robo-advisor.
