best robo advisors
December 27, 2017

Best Robo-Advisors for Investing


Read More

Basic Robo Advisor Questions

Historically, investing was the realm of somewhat well-educated people who could examine trends and charts and predict with some accuracy the fluctuations in the market, and capitalize on them. Robo advisors are pieces of software that do the same thing, except instead of instinct, they use a complex mathematical algorithm to predict gains and losses. Depending on your appetite for risk and reward, a robo advisor may be a good solution. If you are more of a hands-on investor then an automated trading platform may not appeal to you, but there are some benefits to it.

Robo advisors use at least two trading algorithms or theories to process their decisions, the Efficient Market Hypothesis and the Modern Portfolio Theory (MPT). In layman’s terms, MPT proposes that an investment portfolio can be organized in such a way that the rate of return is maximized against the risk appetite of the investor. The Efficient Market Hypothesis states that, despite the large swings in the stock market, stocks will always return to trading at their fair market value. The data sets in support of these algorithms are huge and would take human investors thousands of hours to process, whereas a robo advisor can process it in real time.

Typically, the fees associated with a robo advisor are less than a human advisor. Because it is software-based, you will generally see 1 to 2 percent savings in comparison to a human advisor.

Robo advisors are complex pieces of software that run 24/7 to examine all of the data sets from the previous day and be ready the exact second the market opens. There are no late mornings or bad days for the software. Robo advisors also do not factor instinct into the equation when making investment decisions — the programming that is created when the investor initially answers questions about their desired rate of return and risk appetite will always dictate the investment path.

An IRA is an individual retirement account, and is an investing tool focused on accumulating savings for retirement. A robo advisor is an automated software that will invest on your behalf, based on your appetite risk and desired rate of return. Since you can invest in an IRA directly, you could, in theory, take the gains you earn from the robo advisor and top up your IRA.

Robo advisors use a complex algorithm and multiple investment theories such as the Efficient Market Hypothesis and Modern Portfolio theories. That, combined with big data analytics using data science methods, allows the robo advisor to choose the investments that best match your desired rate of return in conjunction with your risk appetite. In some cases, there can be a human touch to the investments for governance sake, especially in the case of ethical investing, but for the most part it is a hands-off approach.

There are a number of variations of robo advisors. The core functionality is still a piece of software but it manifests in a few ways. There is the pure robo advisor, where you input your data and sit back, as the software does the investing.
There is a hybrid version, also called the human touch. This type of robo advisor has human oversight to ensure that initial setups are completed and verified, and also offer the ability to intercede on the investor’s behalf if the robo advisor isn’t taking advantage of a certain trend — a new IPO for example. Robo advisors would be risk averse as part of the Efficient Market Hypothesis because IPOs tend to trade higher than market value for the initial launch.
There are also robo advisors for certain markets; for example, consumer vs. enterprise. There would be varying levels of support and customization depending on the client needs. There would also be different fee structures for institutional investors as it is a tool to support them rather than a consumer product.

Robo Advisor Tips

  • Since you are trying to maximize your investments, some of the first things you should look at are the associated management fees. Most robo advisors have a pricing structure that bases your annual fee on your total invested assets. Some companies offer incentives that reduce or eliminate fees on your first X amount of dollars, and some just offer a set flat rate. Depending on the size of your investment, this can be a significant impact.
  • Check what other services the robo advisor offers. Investment is fine, but does it also offer the ability to automatically balance portfolios in a way that is most efficient and gives you the most tax benefit? Does it strictly focus on investing and maximum rate of return or does it offer personal finance tools to help you save and make better financial decisions? Does it integrate with your 401k or IRA to make the movement of the returns easier?
  • Consider the diversity of investments and access to other markets. Most robo advisors tend to trade in ETFs but the market isn’t closed to other investment vehicles. Find out if there is something in the product roadmap that will open the robo advisor to other avenues like bonds or even Forex.
  • Finally, consider how much you are investing as some advisors require account minimums to be invested. If you are new to robo advisors and want to ensure that the company’s sales material matches their actual rate of return, look for a company that will allow you to invest a minimal amount so you can judge the quality of the robo advisor.
  • Robo advisors are working 24/7 to ensure that your investments are meeting or beating your desired rate of return. There are a few ways to make and save money with their investment decision.
  • The simplest way to save money is to choose a robo advisor with the lowest fees. It is a competitive marketplace and companies will offer a number of incentives to acquire and keep their customers. Don’t be afraid to leverage the possibility of leaving one robo advisor for another to get the best deal.
  • If you want to increase the money made, be prepared to increase your risk appetite. The robo advisor is software-based and if you move to a higher rate of return with a higher risk appetite, the opportunity to make more money is there. Balance that with the fact that there is also a greater risk of losing money.
  • You can also take your investment gains and put them into another savings vehicle like an IRA, which gives you a tax deduction. Take the money from that deduction and reinvest it back into the robo advisor and create an investment circle.
  • It’s important to remember that a robo advisor is better for long-term investing and it makes better decisions when it has time to evaluate the long-term impact on your portfolio. If your goal is to save for your retirement, then a robo advisor that doesn’t require a lot of input and can be hands-off is a good choice. If you are saving for a house or other short-term purchase, a robo advisor may not be the best avenue for you.