What are Robo-Advisors?

Jul 13, 2022 2:40:38 PM

This blog post is written by Student Advisory Council member, Ryan Leung

Investing comes in many flavors, and one trend that has become more and more popular is the use of robo-advisors. Unlike traditional financial advisors, robo-advisors are digital platforms that provide clients with financial services with little to no human involvement—the services are often entirely automated and driven by algorithms. To start, you fill out a questionnaire about your financial background and goals. Using the information you provide, the robo-advisor then delivers personalized advice and investment recommendations.

The first robo-advisors were used by human wealth managers in the early 2000s, but until 2008, only wealth managers could buy the technology. As a result, clients had to hire a financial advisor to benefit from robo-advisors. Since 2008, this industry has seen rapid growth, and in 2020, robo-advisors managed nearly $1 trillion in assets. By 2025, robo-advisors are expected to manage $2.9 trillion in assets. With the increase in popularity of robo-advisors, read on to learn more about robo-advisors and whether they’re a good fit for you.  

Types of robo-advisors

Generally, robo-advisors can offer various financial planning tools such as retirement calculators to help provide general financial advice. They can also help with the intricacies of managing specific portfolios, including rebalancing portfolios. For instance, if you want to allocate 40% of assets to blue chip stocks, 30% to bonds, and 30% to emerging market equities with ±5% for each asset class, your robo-advisor will automatically rebalance the portfolio if the composition of the portfolio is more than 5% out of sync with your target. This strategy can be done well with robo-advisors, since it can easily be automated, and you can rest assured that your portfolio will be balanced according to your preferences.

Another common use case for robo-advisors is tax-loss harvesting. Essentially, the robo-advisor would sell equities at a loss to offset capital gains tax liabilities in another security. For example, if a S&P 500 ETF goes down in value, the robo-advisor would sell the ETF to lock in a capital loss, while at the same time buying a different S&P 500 ETF. This strategy is good to limit recognition of any short term capital gains and can also be efficiently automated.

Benefits of robo-advisors

The main benefit of robo-advisors is that they are much cheaper than human financial advisors, since the work is automated away. A typical fee is between 0.25% and 0.5%, although there are also many free options available. If you have a balance of $20,000, you could be paying as little as $50 a year. In addition, robo-advisors frequently waive commissions and transaction fees that come with rebalancing portfolios or when depositing/withdrawing money.

Robo-advisors are also more accessible. They can be reached 24/7 as long as you have an Internet connection. The minimum assets needed to register is typically lower ($3,000-$5,000), making them more accessible than human advisors. Moreover, robo-advisors are more efficient in executing trades, both because they are automated, and because you can enact trades at the click of a button, rather than needing to call your advisor and wait for them to make the trade.

However, using robo-advisors limits the number of options available to investors. For example, you cannot buy individual stocks and bonds in your account. As a result, you may be hamstrung by the specific portfolio recommended to you, and you may lack the flexibility to trade the specific securities you want.

Investing is an important part of a secure financial future, and learning about the different investment options available to you is a crucial part of charting your financial path. While robo-advisors have become increasingly popular, they are not for everyone. For more information about robo-advisors and investing, check out this past webinar to learn more!

Tags: Investing