Robo-advisors: what’s behind the virtual financial management?

Those who want to profitably invest their money these days can find numerous online advisors, finance blogs, and YouTube channels that provide necessary background knowledge and in-depth information for a suitable investment strategy. With the robo-advisor in 2013, a new system came onto the market for the first time that would not only give individuals tips with regard to exchange-traded funds, but also take over the entire asset management process according to the user’s wishes. But how exactly does this modern type of financial management work? And which differences are there between the individual providers?

The term “robo-advisor” combines robot and advisor to represent a number of companies in the financial technology sector (so-called FinTech firms) that digitize the classic services of financial advisors. These special online platforms are used to help private investors put together a portfolio of investment products to be automatically monitored by algorithms and modified following developments in the financial market. The term “robo-advisor” is used both for the respective provider and the platform.

Occasionally, the robo-advisor will also automatically take over the rebalancing of investments. It’s not uncommon for the portfolio to change, for example, due to fluctuations in the value of individual positions, i.e. funds deviating from the original strategy. Positions whose values have greatly increased over time then have to be sold proportionately. Positions that have lost value, on the other hand, have to be purchased proportionately. In this way, the original risk-return profile is restored according to the desired investment strategy. The robo-advisor brings the portfolio back into the correct balance.

The algorithmic asset management offers various benefits. Which features individual private investors profit from depends on which type of robo-advisor they use. A distinction is made between full-service, half-service, and self-service systems.

Full-service robo-advisor

The full-service robo-advisor takes cares of all aspects of the financial investment. It suggests an investment strategy to the investor, takes over the complete asset management, and independently takes care of the rebalancing to restore the original investment structure, if necessary. Serious full-service robo-advisors are generally registered as investment advisors with state securities authorities or federally with the SEC, and are required to adhere to all of the same security laws levied on all registered advisors. This allows the robo-advisor to manage your assets in much the same way as a human advisor would.

Half-service robo-advisor

As the name suggests, this robo-advisor offers a limited service. It acts as a broker for its customers, procuring investment products as part of an investment strategy, but as soon as the investment structure has to be adjusted (rebalancing) it requires the approval of the customer. So if you use a half-service robo-advisor, you’re not entirely giving up the management of your investments.

Self-service robo-advisor

The self-service robo-advisor can be regarded as a kind of guide. It only gives the investor tips on the topic of financial investment. The investor has to do all of the asset management (opening securities accounts, purchases, sales, rebalancing) on their own.

In principle, a robo-advisor is suitable for anyone who wants to logically invest money for the long-term and needs professional support for their investment decisions. If you want to use virtual asset management, you should have some background knowledge on the topic of funds so that you can better evaluate the investment proposals. Compared to self-administered management, though, investors don’t have to spend as much energy dealing with individual scenarios and the follow-up decisions themselves. A full-service robo-advisor decides for itself what’s best for the investment structure, and automatically carries out rebalancing during the entire investment period.

If you want to make a profit in the capital market, you should make long-term investments. The same goes for investors that use a robo-advisor and algorithmic investment strategies. For example, if you want to invest your yearly bonus for one year only, then you would be better off considering other alternatives. A robo-advisor is primarily suitable for long-term asset building.

Automated asset management is suitable, though, for those who tend to make emotional decisions when investing money. In the event of price fluctuations, for example, shares are often sold off too quickly for fear of losses. Computer programs, on the other hand, make decisions on the basis of key figures without any emotions and offer dynamic risk management at the same time to stabilize the investment strategy.

Robo-advisors shouldn’t be the first choice for investors with short-term investment goals. Even though the portfolio can be terminated at any time, and the invested assets will be released, the risk of a loss of value could also increase, since there’s no longer extra time for it to be compensated. Compared to a robo-advisor, a classic financial advisor can much better meet the needs of investors who want to invest in the short-term, and can develop the optimal investment strategy according to their individual ideas.

Speculative investors, as well, are not well advised by the virtual asset management. These are people who prefer to invest money in the short-term and at high risk. Of course, the robo-advisor can’t work without any willingness to take risks – after all, the compiled portfolio includes funds that are subject to fluctuations in value. These can’t always be reliably foreseen by algorithms.

Investing in ETFs also gives small investors the opportunity to invest in a broad range of markets and operate systematic asset formation. Because index funds are passively managed, the costs as well as the required effort are comparatively low.

Due to its passive management (in the case of most providers), a robo-advisor is considered a comparatively low-cost option for asset management. The overall cost for the investor, however, depends on the range of service (full- or half-service) as well as the respective provider.

Some providers charge a yearly management fee calculated depending on the investor’s fixed assets. Others focus on the average volume per year – the fee is the calculated monthly, quarterly, or yearly. Since the fees vary strongly between providers, a thorough comparison of robo-advisors beforehand is indispensable. You can find a direct cost comparison of the five most popular providers in the US at the end of the article.

Various comparison portals (such as RoboAdvisors, which looks at the merits of various robo-advisors), online platforms (such as NerdWallet, which provides customers with tips and tools for effective investing), and financial magazines (such as MoneySense, which reports on the latest developments in financial planning) regularly examine providers of digital asset management. The robo-advisor comparisons show how the offers differ in terms of minimum investment, fees, and portfolio composition. We’ve clearly compiled the most important facts for five of the most popular providers in the USA for you here.