Computer Robo-Investor: Strategies For Automating Your Portfolio

Robo-advisors are digital platforms that provide automated, algorithm-driven financial planning and investment services with little to no human supervision. They are designed to help individuals invest and manage their money, offering a low-cost alternative to traditional financial advisors.

Robo-advisors use complex computer algorithms to administer investment portfolios, aiming to take the emotion out of investing and help investors achieve better returns. They are especially useful for retail investors with limited capital and knowledge of the investment world, as they allow for smaller portfolios, easy account opening, and lower fees.

However, robo-advisors also have limitations, such as limited personalisation and lack of human interaction. They may not be suitable for those seeking flexible investing options or those who prefer a more hands-on approach with a financial advisor.

This introduction sets the stage for further exploration of how individuals can turn their computers into robo investing machines, weighing the benefits and drawbacks to make informed decisions.

How to set up a robo-advisor account

Setting up a robo-advisor account is a relatively simple process, but it does require some research and consideration to ensure you find the right provider for your needs. Here is a step-by-step guide on how to set up a robo-advisor account:

• Research and Compare Robo-Advisors: Before opening an account, it is essential to research and compare different robo-advisor providers. Consider factors such as fees, portfolio diversification, customisation options, account minimums, and other features that are important to you. Websites like NerdWallet offer comparisons and reviews of various robo-advisors, making it easier to find one that aligns with your financial goals and preferences.
• Complete the Onboarding Process: Once you have selected a robo-advisor provider, you will typically need to complete an onboarding process. This usually involves filling out a short online survey or questionnaire to assess your financial goals, risk tolerance, investment time horizon, and other relevant factors. This information will help the robo-advisor build and manage your investment portfolio.
• Provide Personal Information: As with opening any financial account, you will need to provide some personal information, such as your name, contact details, and other identifying information. Ensure you have this information readily available to streamline the account setup process.
• Link a Funding Account: To fund your robo-advisor account, you will need to link an existing bank account or another source of funds. This will allow you to transfer money into your new robo-advisor account. Some robo-advisors may offer the option to set up recurring investments or automatic deposits.
• Review and Confirm Your Investment Strategy: After providing your information and funding your account, the robo-advisor will typically present you with a recommended investment strategy based on your responses to the onboarding survey. Review this strategy carefully to ensure it aligns with your goals and risk tolerance. If you are satisfied, you can confirm and finalise your investment strategy.
• Monitor and Manage Your Portfolio: Once your account is set up and funded, the robo-advisor will automatically invest and manage your assets according to the agreed-upon strategy. However, it is important to regularly monitor your portfolio's performance and make adjustments as necessary. Many robo-advisors offer features like automated portfolio rebalancing, tax optimisation, and goal-based planning tools to help you stay on track.

Remember to consider the advantages and limitations of robo-advisors. They offer low fees, accessibility, and convenience but may lack the human touch and sophistication needed for more complex financial situations. Conduct thorough research and carefully evaluate your own financial needs before committing to a robo-advisor.

Pros and cons of robo-investing

Pros of Robo-Investing

Robo-investing has gained popularity in recent years, with many financial companies now offering robo-advisors. Here are some of the benefits:

• Affordability: Robo-advisors are relatively inexpensive, with fees ranging from 0.25% to 0.50% of the total account balance, compared to human advisors who typically charge 1-2%. This makes robo-advisors accessible to retail investors and those with smaller budgets.
• Automation: Robo-advisors remove human emotion from investing decisions and help investors who are uncomfortable with regular investing choices. They also automate the process of portfolio rebalancing, saving time and effort.
• Customization: Robo-advisors allow users to develop portfolios based on their personal risk tolerance, investment frequency, and time horizon. Some robo-advisors also offer enhancements like socially responsible investments (SRI) or smart beta ETFs.
• Long-term focus: Robo-advisors are designed for long-term investors as they are based on routine automated investing over months or years.
• Accessibility: Robo-advisors are digital platforms, making it convenient for investors to manage their finances online or through mobile devices. Some robo-advisors also offer "hybrid" services, providing access to human support when needed.
• Easy to use: Most robo-advisors have user-friendly interfaces and apps that make it simple to monitor investments and add funds.
• Low minimum requirements: Some robo-advisors have low or no minimum account requirements, making it easier for beginners to start investing.
• Time-saving: Robo-advisors manage your investments for you, saving you time and effort in researching and making investment decisions.
• Instant diversification: Robo-advisors use index funds and exchange-traded funds (ETFs) to diversify your portfolio, reducing the risk of significant losses. They also employ rebalancing and tax-loss harvesting strategies to optimise your portfolio.
• Socially responsible investing: Some robo-advisors offer the option to choose investments that align with your values without charging a premium.

Cons of Robo-Investing

Despite their benefits, robo-advisors also have some drawbacks:

• Limited human interaction: While robo-advisors provide customer service, they may not offer the same level of expert advice as human advisors. Access to financial professionals through robo-advisors often comes at an additional cost.
• Narrow investment choices: Robo-advisors typically invest in a limited range of preselected funds, mainly ETFs. This may not suit investors looking for broader investment choices or specific securities.
• Lack of personalisation: Robo-advisors may not consider all your investments and financial circumstances, resulting in a narrow view of your overall financial situation.
• Tax-loss harvesting limitations: While robo-advisors offer tax-loss harvesting, it is only beneficial for taxable accounts and subject to the wash sale rule, which restricts repurchasing a similar security within 30 days of selling.
• Not suitable for complex situations: Robo-advisors may not be equipped to handle complex financial situations, such as estate planning, complicated tax management, or retirement planning.
• Lack of face-to-face interaction: Some individuals prefer the reassurance of face-to-face meetings with financial planners, especially during market downturns. Robo-advisors may not provide the same level of personal connection or comfort.
• Limited alternative investments: Most robo-advisors focus on traditional investing and may not offer alternative investments or strategies.

How robo-advisors work

Robo-advisors are digital investment platforms that use algorithms to automate investment services with minimal human supervision. They are designed to provide accessible, low-cost investment opportunities for ordinary investors. Here's how robo-advisors work:

Onboarding

Robo-advisors typically start by having users complete a short online survey to assess their financial goals, risk tolerance, and investment time horizon. This information is used to determine an appropriate investment strategy and asset allocation for the user.

Investment Strategy and Asset Allocation

Robo-advisors use algorithms to determine the best investment strategy and asset allocation for the user based on the information provided during onboarding. The investment strategy and asset allocation are designed to maximise returns while minimising risk.

Investment Execution

Once the investment strategy and asset allocation have been determined, the robo-advisor will automatically invest and manage the user's assets. Robo-advisors typically invest in exchange-traded funds (ETFs) to provide broad diversification and manage investment returns and market risk.

Monitoring and Rebalancing

Robo-advisors continuously monitor the user's portfolio to ensure it remains aligned with the target asset allocation. If the portfolio drifts too far from the desired allocation, the robo-advisor will automatically rebalance it to get back to the original targets.

Additional Features

Some robo-advisors offer additional features such as tax-loss harvesting, goal-based financial planning tools, and socially responsible investment options.

Fees

Robo-advisors typically charge lower fees than traditional financial advisors. The fees are usually based on a percentage of the user's account balance or a flat annual fee.

How robo-advisors get paid

Robo-advisors are paid through their account management fee. This is usually shown as a percentage, such as 0.25%. This means the fee is a percentage of the money that you invest. For example, if you put $1,000 into a robo-advisor investment account, and it charges a 0.25% fee, you'd pay $2.50 for that year's worth of investment management. If you put in $100,000 you'd pay $250. These fees are significantly lower than those of traditional financial advisors.

Robo-advisors also make money through payment for order flow (PFOF). This payment results from directing trade orders to a particular market maker. Robo-advisors can also earn money by marketing financial products and services to their customers, such as mortgages, credit cards, or insurance policies.

Robo-advisors typically charge lower fees than traditional financial advisors. A human advisor will usually charge an annual fee of 1-2% of a client's total account balance, whereas a robo-advisor's advisory fee ranges from 0.25% to 0.50%.

It's important to note that expense ratios are different from management fees. Expense ratios are paid to the people and institutions that manage the funds you're invested in, not to the robo-advisor.

When deciding whether a robo-advisor is right for you, it's essential to consider factors such as affordability, automation, customisation, long-term focus, and accessibility. While robo-advisors offer many benefits, they may not be suitable for everyone, especially those with complex financial needs or those who prefer a more hands-on approach to investing.

How to evaluate a robo-advisor

When evaluating a robo-advisor, it's important to consider your financial goals, risk tolerance, and preferences. Here are some key factors to help you make an informed decision:

• Affordability: Robo-advisors typically charge lower fees than human advisors. Compare the advisory fees, which usually range from 0.15% to 0.5% of the assets under management. Also, consider any additional costs, such as setup fees or transaction costs.
• Automation: Robo-advisors use algorithms to automate investment decisions and portfolio management. This removes human emotion from the process but may require initial human input for portfolio construction.
• Customization: Evaluate whether the robo-advisor offers personalized portfolios aligned with your risk tolerance, investment preferences, and time horizon. Some robo-advisors provide enhancements like socially responsible investments or smart beta ETFs.
• Long-term Focus: Robo-advisors are generally designed for long-term investors, as the benefits of routine automated investing are realised over time. If you're an active trader seeking quick gains, a robo-advisor may not be ideal.
• Accessibility: Robo-advisors offer digital access, making it convenient to manage your finances online. Some robo-advisors also provide "hybrid" services, giving you the option to connect with human advisors when needed.
• Services: Identify the specific financial advice and services you require. While portfolio management and asset allocation are standard, some robo-advisors offer additional services like budgeting, financial planning, and tax-loss harvesting.
• Performance and Risk: Understand the robo-advisor's investment strategy and its potential impact on your returns. Evaluate if their approach aligns with your risk tolerance and financial goals.
• Regulation and Security: Ensure the robo-advisor is registered with the SEC and complies with relevant securities laws and regulations. Also, check for insurance coverage, such as SIPC protection, to safeguard your investments.
• User Experience: Consider the ease of use and the level of customer support provided by the robo-advisor platform. This includes the account setup process, the availability of educational resources, and the responsiveness of their support channels.
• Reviews and Reputation: Research the robo-advisor's track record and client testimonials. Look for independent reviews and ratings from reputable sources to assess their performance, reliability, and overall client satisfaction.

Remember to weigh these factors based on your individual needs and preferences. Evaluating robo-advisors comprehensively will help you make a well-informed decision about which platform is the best fit for your financial goals and investment style.

Frequently asked questions