What’s a Robo-Advisor, and Do I Need One?

A robo-advisor is an option between a no-advice approach and a financial advisor. Whether you need one or not depends on your investment profile and needs

Francesco Lavecchia 29 July, 2022 | 10:44AM
Facebook Twitter LinkedIn

Robot Arms Raised 

Should do you all of your investments yourself? Or should you pay someone to do it for you? Traditionally, these were the two options available to retail investors worldwide. For the first option, the assumption is that you have the expertise, skill, and (continuing) education to successfully invest for yourself. For the second, you need the financial recourses (and commitment capacity) to pay for and work with a human advisor.

But what if you have some expertise and knowledge, but not enough ready money to pay for an advisor? Up until even a decade ago, your only options would have been to either build up your skills, or save up until you could afford an advisor. Not anymore.

IN many markets now, there’s a third option that falls somewhere in between a do-it-yourself trading platform driven portfolio, and a personalized wealth management team: that is a robo-advisor.

Robo-advisors are digital platforms that use computer algorithms to build automated portfolios with a targeted risk level. Most of them also offer investors digital investing advice, often at a fraction of the cost of a full-service financial advisor.

Robo-advisors start by asking you to fill a basic questionnaire geared toward understanding your investing goals, time horizon, and risk tolerance. (You can see an example of a risk tolerance questionnaire here – this one is a Morningstar developed questionnaire for U.S. based investors.)  Once you fill out the questionnaire, a robo-advisor will match your answers to an investment portfolio that best fits your needs. The portfolios on offer are usually made of low-cost, passively managed funds.

How Do Robo-Advisors Work?

Robo-advisors have lower fees and low or even nonexistent investment minimums, so you do not need a lot of cash on hand to begin your investment journey with one. You could open an account for as little as £5,000 or less. What this means is that even if you are a new investor or have a small balance you may find it very appealing. 

Digital advice is cheaper compared to what a real-life advisor would charge. Morningstar surveyed more than a dozen robo-advisors and found the median advisory fee stood at 0.30% of assets per year. A traditional financial advisor typically charges 1%. So, if you have a £500,000 portfolio you will pay £5,000 a year with a traditional advisor, while a robo-advisor will cost you £1,500 a year.

By the way, it is important to remember that the cost of these platforms depends on variables such as the type of services you choose and the amount of the sum you are investing.

Robo-advisors typically steer younger clients or more-aggressive investors to portfolios heavier in stocks or other volatile assets, and they recommend portfolios heavier in bonds or less-volatile assets to older or more conservative investors. The level of personalized financial planning increases as one moves from digital advice toward traditional advice.

Is a Robo-Advisor a Good Fit for Me?

Robo-advisors can be a good option for some investors, but they are not for everyone. Here are some instances in which a robo-advisor might not work for you:

  • If you have a low risk profile, you are not able to invest in autonomy and you are not particularly accustomed to automated solutions and your goal is to preserve the capital through a secure and transparent service, then a traditional business models and an interaction with a human consultant will meet your needs.

  • If you have a low to medium risk profile, your goal is to increase your capital in the long term, if you want to be in control of your investments, but still, you do not feel fully secure in investing without the advice of an expert, then an advanced robo-advisors can be your choice. Many platforms have tried indeed to bridge the gap between digital and human investment advice by incorporating real-time behavioral nudges via text or email to encourage users to stick with their investment plans and continue taking the steps needed to meet their goals.

  • If you have a higher risk profile, you enjoy spending time managing your investments and you want to invest without outside advice, than you will be not satisfied with the traditional system and you would be very keen to adopt innovative management solutions such as a robo-advisor. This is very common among younger generations who grew up with Internet and social media at their fingertips and that may actually prefer not to meet with anyone in person. To meet the preferences of young and tech-savvy investors some platforms have tailored their offerings to maximize tech capabilities and minimize human interaction.

 

 

 

 

The information contained within is for educational and informational purposes ONLY. It is not intended nor should it be considered an invitation or inducement to buy or sell a security or securities noted within nor should it be viewed as a communication intended to persuade or incite you to buy or sell security or securities noted within. Any commentary provided is the opinion of the author and should not be considered a personalised recommendation. The information contained within should not be a person's sole basis for making an investment decision. Please contact your financial professional before making an investment decision.

Facebook Twitter LinkedIn

About Author

Francesco Lavecchia

Francesco Lavecchia  è Research Editor di Morningstar in Italia