Robo Advisors are automated financial planning and investment services that use advanced mathematical algorithms to make investment decisions with little human interference. Robo Advisors are cheaper and more accessible than traditional financial advisors, making it easy for anyone to start building their investment portfolio.
Robo Advisors are digital platforms that provide automated financial planning services based on mathematical algorithms. They require little to no human interference. Robo Advisors are also used to gather data to provide insights. Thus, they can help you make more informed investing decisions.
Understanding Robo advisors is essential. However, it’s critical to consider the pros and cons of using them instead of human financial advisors. Here is everything you need to know.
Table of Contents
#1. Eliminating Financial Barriers
#2. Simplifying the Investing Experience
#3. Welcoming Younger Investors
#2. Removes Emotional Investing
#3. Limited Flexibility and Personalization
#3. Investors Comfortable with Technology
When Is It Better to Work with a Financial Advisor?
What Is a Robo Advisor?
Robo Advisors are digital alternatives to humans. They provide financial planning and investing services without much external influence. The first version, called Betterment, was launched back in 2008. Meanwhile, the technologies have only gotten more sophisticated since then.
Betterment’s purpose was to help people and businesses rebalance their assets within target-date funds. Target-date funds are mutual funds that allocate capital based on an investor’s needs at a specific time. Managing the tiny details of those activities can be daunting, so using Robo Advisors makes sense.
Robotic financial advisors manage passive tasks and monitor investments, leaving human hands open for other assignments. Organizations appreciate the increased efficiency and have beckoned the market for more. Additional options are now available for people who want to customize their portfolios.
Examples of Robo Advisors
There are several options to choose from when looking into working with a robot advisor. Some of the best include:
Each platform offers unique features with different fees and portfolio minimums. Consider them carefully before investing your money.
How Do Robo Advisors Work?
Market indexes measure the value of a group of investments, similar to mutual funds. Most Robo Advisors use passive indexing strategies optimized by modern portfolio theory (MPT). Passive indexing is investing in market indexes through either an exchange-traded fund (ETF) or an index fund.
Modern Portfolio Theory is defined as a method for selecting investments to maximize their overall returns with an acceptable level of risk. MPT is a good practice for risk-averse investors who want to build an efficient, diverse investment portfolio. ETFs and index funds are meant to diversify, track indexes, and serve as a cheaper alternative to actively managed mutual funds.
A.I. advisors gather information about clients through an online survey to understand who they are and what kind of investing they’re looking to do. The algorithm will then start making investments for the client based on the information gathered in their survey. This straightforward approach typically helps in democratizing investing.
Democratizing Investing
Robo Advisors make investing more accessible and significantly broaden the investing world and who can participate. They are great tools for first-time investors who may need extra help when it comes to making informed investment decisions.
Using an A.I. investment advisor is easy, but it is also more affordable. Organizations and individuals can get into investing without substantial capital because Robo Advisors eliminate the need to hire a traditional broker. In that way, they help enhance accessibility to lucrative investment circles. These are three of the other democratizing advantages:
- Eliminating financial barriers
- Simplifying the investing experience
- Welcoming younger investors
#1. Eliminating Financial Barriers
Before Robo Advisors existed, you had to hire an in-person financial expert to invest capital. Hiring typically involved long meetings and limited availability. Meanwhile, traditional firms usually favor clients with massive portfolios and profitable ventures. This left small-time investors at a significant disadvantage.
Many financial advisory firms also establish account minimums to deter specific groups. Unfortunately, account minimums aren’t the only obstacle. Unlike low-cost robotic advisors, in-person expertise involves fees and additional costs.
Robo Advisors are much cheaper, however. This is because Robo Advisor companies don’t need to pay human advisors. They can offer lower prices and lower account minimums that more people can afford. This artificial intelligence is for the underdogs.
Traditionally, financial services were reserved only for the people who could afford them. Services include organizing your finances, managing investments, and creating long-term financial plans. Because traditional advice comes at a premium, only specific groups with relatively high incomes can work it into the budget. A.I. performs similar functions at a fraction of the cost while making the services more widely available.
#2. Simplifying the Investing Experience
Many people find the concept and process of investing too complex and time-consuming. This truth can deter some of them from building their investment portfolios. Financial literacy, or lack thereof, is also a concern.
Portfolios require regular maintenance, which can be even more of a headache. That’s especially true for people who don’t understand how the economy works—fortunately, many Robo Advisors provide simple financial guidance to help people through investing their first dollar.
#3. Welcoming Younger Investors
Solid financial advice and investment strategies have been traditionally limited to people with substantial portfolios. That’s why younger investors often look for alternatives. They either lack the assets to be taken seriously, or they don’t feel comfortable working with staunch firms founded on outdated principles.
This, coupled with the cost of traditional financial advisors, can make it extremely difficult for young investors to start building their portfolios. Robo Advisors give them a modern alternative because they are a cheap, accessible, and low-maintenance option.
Robo Investing Pros
Making the financial world more accessible helps democratize investing. However, there are other benefits to using Robo Advisors, including these:
- Efficiency
- Removes emotional investing
- Enhances portfolio
#1. Efficiency
Robo Advisors provide more ease of use and streamline the investing process. Instead of calling or physically meeting with a financial advisor to execute a trade or make an investment, people can manage their portfolios digitally on the go.
Working with a robotic financial firm is more efficient than traditional financial advisors. That’s especially true for investors who don’t have the time to meet with a financial advisor in-person or via a phone call. People can make their investments independently instead.
#2. Removes Emotional Investing
Typically, when people invest independently, they decide based on what the market has recently done rather than looking at its long-term functionality. Emotional investing can cause some portfolios to underperform. However, Robo Advisors don’t operate that way.
They make investment decisions based on sound research and data rather than human emotions. This can make investing more efficient and informed in the long term. It can also help people avoid the trappings of clever appeals.
#3. Enhances Portfolio
Because robotic financial advisors use advanced mathematical algorithms to determine the best investments, you can quickly enhance your portfolio with them. Computerized advisors can also make investments based on the client’s current financial situation and future goals. This helps people ensure their money goes to the right place.
Robo Investing Cons
While technology can make investing more accessible, there are still some disadvantages. Here is what you need to know:
- No face-to-face meetings
- No emotional management
- Limited flexibility and personalization
#1. No Face-to-Face Meetings
There is undoubtedly a convenience when working with Robo Advisors instead of traditional financial experts. Yet, the lack of human interaction and face-to-face meetings may not suit everyone. Most robots offer some degree of customer service, but this typically comes in a live chat and isn’t the same experience as chatting with an advisor in person.
#2. No Emotional Management
Taking the emotion out of investing has its benefits. Still, sometimes investors may need emotional support from their advisors, especially novice investors. If the market tanks dramatically, you might panic and want to sell your stocks to avoid losing money. Robo Advisors don’t have feelings, so they won’t have the same reaction you might have in a situation like that.
This is when it may be helpful to have a human advisor on the line that can reassure you when you are in a panic. While Robo Advisors’ algorithms are reliable, there is no emotional human being to connect with in times of stress.
#3. Limited Flexibility and Personalization
Robo Advisors have limited personalization and flexibility. While they require you to fill out an online survey to understand your financial needs and plans, they’re not entirely tailored to you personally. Typically, they’ll use your data to recommend a specific investment plan like an aggressive growth or income-oriented plan.
While you can choose which plan you accept, they are not usually customizable. Suppose you are looking for investment management tailored to you specifically and customizable from start to finish. It may be better to work with traditional financial planners instead of Robo Advisors.
Who Should Use Robo Advisors?
Robo Advisors are a practical investment tool for people who are just getting into investing and may not be ready to invest in a full-time financial advisor. Some types of investors who may see the most benefits from using a robotic assistant include:
- New investors
- Less wealthy investors
- Investors comfortable with technology
- Passive investors
#1. New Investors
Robo Advisors are helpful for younger and inexperienced investors who aren’t familiar with investing or how the market works. Learning efficient investment strategies and financial jargon can also take time and effort. Luckily, Robo Advisors do all that work for you and make it easy to get started as an investor.
#2. Fewer Wealthy Investors
There is little to no minimum account or portfolio requirement when working with Robo advisors. The associated fees are relatively small. This makes it easy for anyone to start building their investment portfolio, regardless of their net worth or income.
#3. Investors Comfortable with Technology
Robo Advisors operate exclusively online, using algorithms and artificial intelligence to make decisions. Because of this, it’s essential to understand and be comfortable using technology to trust a robot with your money and financial decisions.
#4. Passive investors
Robo Advisors are fully automated and don’t require any interference from the investor. This makes them an excellent option for investors with limited time to build up their portfolios in the background.
When Is It Better to Work with a Financial Advisor?
Investors looking for high flexibility and emotional reassurance may be better off with a traditional financial advisor. Human financial advisors can also be valuable when working with volatile markets, like the one resulting from the COVID-19 pandemic. This is because you can have a real-life conversation with your financial advisor. They usually have years of market experience to harness.
Realworld financial advisors are also better options for people approaching retirement. Robo Advisors don’t have the capacity for personalization that may be necessary for investing in retirement, especially when considering how many personal and financial factors are at play with those kinds of decisions.
Conclusion
Robo Advisors are digital alternatives to humans that provide automated financial planning and investing services. They are based on mathematical algorithms without any human interference required. These are practical tools for first-time investors who may need extra help when making investment decisions.
The amenities also come at a fraction of the cost of traditional financial advisors. Therefore, robotics and A.I. help democratize investing, making it more accessible by broadening the horizons for those who use it.
