How robo-advisors manage investments

Automated services offer affordability and convenience.

Ready to explore an affordable way to choose and manage investments? You may want to consider a robo-advisor, which is a type of automated investing. Robo-advisors can potentially simplify investment management and financial planning for consumers.

What is a robo-advisor?

According to Investopedia, a robo-advisor is a “digital platform that provides automated, algorithm-driven financial planning and investment services with little to no human supervision.” A typical robo-advisor collects information about your finances, assets and goals. You’ll often provide these details by completing an online questionnaire. 

The digital advising service also considers the appropriate level of investment risk for your situation, known as risk tolerance. The robo-advisor can then use the various information collected to offer financial solutions. It will build you a portfolio and automatically invest your assets.

When did robo-advising begin?

The automated digital advisory services were first launched for public use in 2008, and they’ve been adopted by many investors worldwide. Global data provider Statista estimates there will be 49.04 million users in the U.S. by 2027.

Today’s sophisticated robo-advising tools can help with personal asset management. Robo-advising first emerged as a basic and affordable suite of tools to help investors construct and rebalance their portfolios. Its popularity has continued to grow with all types of investors. In 2023, the Business Research Company published a Robo Advisory Global Market Report. It estimated that the global robo-advising market grew from $28.24 billion in 2022 to $41.52 billion in 2023.

How do robo-advisors work?

Most of the digital robo-advisors utilize the modern portfolio theory (MPT). With MPT, investments are chosen to help you maximize returns without taking on too much risk. A key element of this method is creating a diversified portfolio of investments, which the robo-advisor will help you build. The advisor manages your portfolio automatically over time, working to keep you on track for the future. 

Though a robo-advisor offers general portfolio management, some do employ more complex strategies like tax-loss harvesting — a technique to help reduce a tax burden. A robo-advisor can also respond to market conditions and adjust how your assets are allocated. However, investing still comes with some risk of loss whether you select a robo-advisor or a human one. 

Why do investors use automated investing?

Investors choose these digital financial services for a variety of reasons, including:

  1. Affordability. Cost is a big part of the appeal of automated investing. For example, management fees are lower when compared to human advising. Robo-advisors have an annual flat fee of around 0.5% of your total account balance compared to the 1% to 2% fees generally charged by a human financial advisor.
  2. Adaptability. Whether you’re just starting to invest or have an established portfolio, robo-advisors can offer all types of investors cost savings and efficiency. The services can work for adults of all ages, including those approaching or in retirement. 
  3. Innovation. Robo-advisors can help investors tap into every corner of the market — from exchange traded funds (ETFs) to hedge funds. Through innovative tools, a robo-advisor can establish, manage and even rebalance your portfolio automatically.  
  4. Automation. Managing multiple investments can be time-consuming, especially when life changes. You may have children, start a business, buy property or consider retirement. Throughout your financial journey, robo-advisors automate the work for you. They even offer mobile apps to access your account on the go. From the app, you can often check your balance, review your returns, make deposits or withdraw funds.
  5. Flexibility. Financial advisors may recommend investment strategies that combine automated investing with personal account management. They tout this method as a way to maximize investment performance. Adding a human component to the robo-advisor formula gives consumers more guidance. This approach can be especially helpful when setting up your portfolio. 

 

How do you choose a strategy?

Today’s automated investing tools offer general portfolio management. They can’t deliver tailored advice or complicated financial plans. That means more complex investing strategies like estate planning should be left to a human advisor who has demonstrated expertise. 

Whether you’re using a robo-advisor or a human one, make sure you do your research. Be sure you understand the services provided and the fees you’ll pay. 

Personalized help — Competent human advisors can offer guidance during periods of market upheaval and design solutions that fit your long-term goals. The SEC offers tips on selecting a financial professional, including how to check out the credentials — such as their Certified Financial Planner designation — of a human advisor. When you interview potential advisors, try to determine if they’ll put your interests first. A “fiduciary advisor” is a type of financial professional who must legally and ethically act in their clients’ interests. 

Automated assistance — An SEC Investor Bulletin on robo-advising recommends you make sure your robo-advisor and constructed portfolio are “a good match for your investment needs and goals, and that you understand the potential costs, risks, and benefits of using that particular robo-adviser.” You’ll also want to choose a digital advising service that’s licensed and registered with the U.S. Securities and Exchange Commission. 

Compare several robo-advisors in terms of fees, investment minimums, services and support before selecting one. Remember, you can always discuss robo-advisor and online investment options with a financial expert, especially if you’re new to investing.


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