The Rise of Robo-Advisors: Is Automated Investing Right for You?

Last Updated on May 18, 2023

The Rise of Robo-Advisors

Automated investing or robo-advising has revolutionized the investment industry in recent years. Robo-advisors are digital platforms that provide automated investment management services to clients.

These platforms use algorithms and artificial intelligence to create and manage investment portfolios for individuals. The robo-advisor industry has grown rapidly in the past few years, with assets under management (AUM) increasing from $5 billion in 2013 to $1.2 trillion in 2020, according to a report by Backend Benchmarking.

In this blog post, we will discuss the rise of robo-advisors and help you determine if automated investing is right for you.

What are Robo-Advisors?

Robo-advisors are digital platforms that offer automated investment management services to clients. These platforms use algorithms to create and manage investment portfolios for individuals.

The process of creating a portfolio is based on the individual’s risk tolerance, investment goals, and other factors such as time horizon and income. The robo-advisors provide recommendations on asset allocation, investment selection, and rebalancing, based on the individual’s preferences.

Basically, a typical robo-advisor will conduct an online survey to inquire about your financial position and future objectives. The data is then used to provide guidance and carry out automatic investing on your behalf.

The Growth of Robo-Advisors

The Growth of Robo-Advisors

The origins of robo-advisors can be traced back to the early 2000s, when the first digital platforms were created to provide investment advice to individuals at a lower cost than traditional financial advisors. However, it wasn’t until the mid-2010s that the concept really took off, with the emergence of companies like Betterment and Wealthfront. Today, robo-advisors are disrupting the financial industry by providing a convenient and affordable way for individuals to manage their investments.

The current state of the robo-advisor industry is characterized by rapid growth and increasing competition. According to a recent report by Business Insider Intelligence, robo-advisors are expected to manage over $1 trillion in assets by 2023, up from just $60 billion in 2016.

This growth is being driven by a number of factors, including the increasing popularity of passive investing, the rise of millennials as a key demographic, and the growing trend towards digital financial services.

As a result, there has been a proliferation of new entrants into the market, including traditional financial institutions like Vanguard and Charles Schwab, as well as newer players like Robinhood and Stash.

How do Robo-Advisors work?

Robo-advisors use a series of algorithms to determine the best investment strategy for an individual. The process of creating a portfolio involves several steps, including:

  1. Gathering information: The robo-advisor collects information about the individual’s investment goals, risk tolerance, time horizon, income, and other factors. This information is used to create a customized investment portfolio.

  2. Asset allocation: The robo-advisor uses the information collected to determine the appropriate asset allocation for the individual. The asset allocation will depend on the individual’s investment goals, risk tolerance, and time horizon.

  3. Investment selection: The robo-advisor selects the appropriate investments for the individual’s portfolio based on the asset allocation determined in step 2. The investments can include stocks, bonds, ETFs, mutual funds, and other assets.

  4. Rebalancing: The robo-advisor continuously monitors the individual’s portfolio and rebalances it as needed. Rebalancing involves adjusting the asset allocation to ensure that the portfolio remains aligned with the individual’s investment goals and risk tolerance.

Factors to Consider When Choosing a Robo-Advisor

Choosing a robo-advisor can be a daunting task, but by considering certain factors, you can ensure that you find the right provider for your investment goals. Here are some factors to consider when choosing a robo-advisor.

The Human Factor

The depths of computers do not magically produce completely developed robo-advisors. They are being programmed by a human being in the background. And you want to confirm that their views on risk and financial tactics are compatible with yours.

Additionally, even though robots can be excellent investors, you undoubtedly want to be able to get in touch with a person if something goes wrong. AI is viewed as a threat to mankind by some, while it is also seen as the future by others. Choose your landing spot while taking into account the company’s general responsiveness and the calibre of its customer support.

Investment Strategies Offered

The first thing to consider when selecting a robo-advisor is the investment strategies it offers. Different robo-advisors may use different approaches, such as passive indexing or active management. It’s essential to understand how each strategy works and which one aligns with your investment goals and risk tolerance.

For instance, if you are a long-term investor with a low-risk tolerance, you may prefer a robo-advisor that uses passive investing, while if you are a more aggressive investor, you may want to choose an active management approach.

Fees and Charges

The fees and charges associated with a robo-advisor can vary widely, so it’s essential to compare providers carefully. While robo-advisors are generally less expensive than traditional financial advisors, you still want to ensure that you are getting good value for your money.

Look for a robo-advisor that is transparent about its fees and charges reasonable rates. For example, some providers charge a percentage of assets under management, while others charge a flat fee.

Level of Automation and Customization

Robo-advisors can offer different levels of automation and customization, so it’s essential to choose a provider that aligns with your preferences. Some robo-advisors offer fully automated investment portfolios, while others allow for more customization and control.

If you are comfortable with a high degree of automation, you may prefer a robo-advisor that offers little customization. Conversely, if you prefer more control over your investments, you may want to choose a provider that offers more customization.

Track Records

Some businesses have been around for a very long time, so you can get a good feel of their financial health when choosing which ones to invest in. Robo-advisors themselves have only been around for a few years, but you can still look at their historical results. Make careful to look past their own evaluation of that performance, which is probably positive.

Related: From Novice to Knowledgeable: A Comprehensive Guide for New Investors

How to Get Started with a Robo-Advisor

Robo-advisors are a great option for people who want to invest in the stock market but may not have the time or expertise to manage their own portfolios. If you’re interested in getting started with a robo-advisor, here are some steps you can take:

Steps to open an account with a Robo-Advisor
  1. Research and choose a robo-advisor that meets your needs: There are several robo-advisors to choose from, each with different fees, investment strategies, and features. Some popular robo-advisors include Betterment, Wealthfront, and Vanguard Personal Advisor Services. Research each option and choose the one that aligns with your investment goals and risk tolerance.

  2. Complete the online account setup process: Once you’ve chosen a robo-advisor, you’ll need to create an account by filling out an online form with your personal information, financial goals, and investment preferences. You’ll also need to provide documentation to verify your identity.

  3. Choose an investment portfolio: The robo-advisor will analyze your financial information and recommend a portfolio that’s aligned with your goals and risk tolerance. You can choose to accept the recommended portfolio or customize it to your liking.

How to fund your account
  1. Link your bank account: To fund your robo-advisor account, you’ll need to link it to your bank account. This can typically be done through the robo-advisor’s online platform.

  2. Set up recurring contributions: To make investing more convenient, you can set up automatic recurring contributions from your bank account to your robo-advisor account. This will ensure that you’re regularly contributing to your investments without having to think about it.

Tips for monitoring and adjusting your portfolio
  1. Regularly review your portfolio: Even though robo-advisors are designed to be automated, it’s still important to periodically review your portfolio to ensure that it’s aligned with your goals and risk tolerance. Many robo-advisors provide tools to help you monitor your portfolio’s performance.

  2. Consider rebalancing your portfolio: Over time, the allocation of assets in your portfolio may become unbalanced due to market fluctuations. To maintain a consistent risk level, consider rebalancing your portfolio periodically.

  3. Stay disciplined: One of the benefits of using a robo-advisor is that it takes emotions out of the investment process. However, it’s still important to stay disciplined and avoid making impulsive investment decisions based on market fluctuations.

Advantages and Disadvantages of Using Robo-Advisors

Robo-advisors are digital platforms that use algorithms and computer models to provide automated financial advice and portfolio management services to clients. Here are some advantages and disadvantages of using robo-advisors:

Advantages:
  1. Cost-effective: Robo-advisors generally have lower fees than traditional financial advisors, making them a more affordable option for people who want to invest with lower minimum investment requirements.

  2. Accessibility: With robo-advisors, investment advice and management services are accessible 24/7 through online platforms, which means you can manage your investments anytime and anywhere, without needing to schedule an appointment with a human advisor.

  3. Automated investment strategies: Robo-advisors use sophisticated algorithms to analyze your financial goals, risk tolerance, and investment horizon, and then create an investment portfolio that’s aligned with your objectives. This automated approach can help to minimize the risk of human error.

  4. Diversification: Robo-advisors often invest in exchange-traded funds (ETFs) that have a diverse range of underlying assets, which can help to spread your investment risk across multiple assets.

Disadvantages:
  1. Lack of personalized advice: Robo-advisors are limited by their reliance on algorithms and computer models, which means that they cannot provide personalized financial advice that takes into account a client’s unique financial situation, goals, and preferences.

  2. Limited human interaction: With robo-advisors, you won’t have the opportunity to discuss your investment strategy with a human advisor, which may not be suitable for clients who value a human touch in their financial planning.

  3. Limited investment options: Robo-advisors generally offer a limited range of investment options, typically consisting of ETFs and mutual funds, which may not be suitable for clients who want to invest in individual stocks or other more complex financial products.

  4. Reliance on technology: Robo-advisors are dependent on technology, which means that they may be vulnerable to technical glitches or outages that could impact the accuracy of their investment advice.

Related: 5 Common Investing Mistakes The Rich Make

Conclusion

Looking to the future, the robo-advisor industry is expected to continue to grow and evolve in a number of ways. One trend that is likely to gain traction is the use of artificial intelligence (AI) and machine learning to improve investment performance and personalize advice for individual investors.

Another area of potential growth is in the integration of robo-advisors with other financial services, such as banking and insurance. Finally, robo-advisors are expected to expand globally, with increasing adoption in markets outside of North America and Europe.

Overall, the growth of robo-advisors is likely to continue to disrupt the financial industry and provide new opportunities for investors and financial services companies alike.

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