Robo-advisors are increasingly popular, largely due to lower fees and minimum investment requirements, relative to traditional advisors. They do provide an inclusive approach to financial planning. But what is a robo-advisor? Here is that and more.
Introduced about a decade ago, robo-advisors have entered the mainstream investor space, with many more options now available.
Because of generally low starting deposits and the fact that no in-depth market knowledge is required, these online advisors are popular with new investors. Likewise, experienced investors can benefit from the automation of time-consuming and complex activities such as tax-loss harvesting and rebalancing.
But what exactly are robo-advisors? They generally are digital financial planning and investment services offered by brokerage firms which, based on investor preferences, provide automated investment portfolios with little to no human input or supervision.
Basically, robo-advisors can help investors put their money to work — so they do not have to.
Robo-advisors take personal preferences — usually time horizon, financial goals, and risk tolerance — and weigh them against unpredictable forces such as asset class performance, market volatility, and market conditions.
How specific robo-advisors work varies, but they generally operate similarly. To start, each investor usually fills out an online questionnaire so that their investment needs and risk tolerance can be assessed. Investor “needs” can be anything — from financing children’s education to purchasing a new vehicle.
Subsequently, the robo-advisor will use the data to offer advice and automatically make investments. The platform will craft a personalized portfolio of funds, typically chosen by a professional investment team. Often, the investor will be allowed to link their bank account to facilitate robo-advisor account funding.
To ensure that the investor’s holdings are properly rebalanced by advanced algorithms, professionals usually monitor what the market is doing as well as each underlying investment.
To track their progress, investors can log into their account where they can also tweak goals or add contributions.
Some robo-advisors also offer access to a live consultant who can help investors prioritize objectives and offer recommendations on how to get there. Most firms also offer a combination of both approaches.
Top automated invested advisors provide easy account establishment, account services, robust objective planning, portfolio planning, education, low fees, and security features.
Betterment and Wealthfront were the first robo-advisors, having launched in 2008. Initially a mutual fund company with designs on the tech community, Wealthfront soon discovered that computer software could improve the accessibility of investment advice.
Betterment, though, started out seeking to rebalance assets within target-date funds through the passive management of buy-and-hold investments via a basic digital interface.
The technology was not novel — wealth managers have employed automated portfolio allocation software for about 20 years. But before Betterment and Wealthfront opened, it was wealth managers exclusively who could purchase the technology. Thus, clients were forced to hire a financial advisor to take advantage of the innovation.
These days, most robo-advisors build passive wealth for clients through portfolio theory, or some variation of what is known as modern portfolio theory, which is a mathematical framework for crafting a portfolio in a way that maximizes returns for a given risk level. Usually, the investor may not select which exchange-traded funds or mutual funds in which to invest. They also may not buy individual stocks or bonds.
There are some robo-advisors that offer portfolios optimized for socially responsible investing, strategic approaches that act like hedge funds, or halal investing. Some are sophisticated enough to take care of investment selection, tax-loss harvesting, and retirement planning.
Overall, there is a definite market for robo-advisors, as client assets they manage were projected to hit $3 trillion this year, and $5 trillion globally by 2027.
Once the portfolio is created, robo-advisors use rebalancing bands to monitor accounts to ensure maintenance of optimal asset-class weightings. With such bands, each security or asset class receives a target weight and a commensurate tolerance range.
Some robo-advisors use what is called tax-loss harvesting, an approach that calls for unloading securities at a loss to counter a capital gains obligation. Harvesting is usually used to cap the recognition of short-term capital gains. To do this, robo-advisors maintain at least two stable ETFs for every asset class.
Using a robo-advisor alone could work best for investors who have a single investment goal. The investor can stay atop their progress online, although financial planning advisors are not typically provided. Fees are relatively low.
Using a robo-advisor in addition to a traditional advisor could be more suitable for an automated portfolio developed with professional guidance. Fees will be higher due to occasional financial counsel.
Investors who go with just a traditional advisor will pay much more for what are usually more complex services like estate planning. And because investors will have help with all their accounts, they can develop a holistic view of them. Moreover, investors are able to meet in person with their advisor. The dedicated attention and heightened advisor accessibility will cost, though.
Note that most robo-advisors are paid through what is called a wrap fee based on assets under management (AUM), and charge about 0.3% of AUM annually. They also make money through payment for order flow, resulting from directing trade orders to a certain market maker, which can lead to improved execution prices.
Also, robo-advisors can bring in earnings through the marketing of financial products and services including credit cards, insurance policies, and mortgages.
Due to robo-advisors, retail investors and others can avail themselves of solid financial planning — not just the wealthy.
Traditional financial advisors will manage their client’s investments. They also generally help them with their savings and retirement planning. Here are some of the primary benefits that robo-advisors have over traditional advisors:
There are pros and cons to everything, including robo-advisors. Disadvantages can include:
Investors will need to do some research when searching for a robo-advisor, since there are varying costs and areas in which they excel.
Some online platforms target and seek to lure demographics such as Gen Z and Millennial investors who are comfortable with technology and are still accumulating assets. This population is generally more familiar with using technology for key tasks including wealth management.
In general, investors should consider the services provided, compare expenses, and evaluate the cost and fees.
A major feature of robo-advisors is that it relieves the investor of the need for extensive market knowledge; algorithms do most of the work.
Similarly, investing through a private-market platform such as Yieldstreet avails investors of curated and highly vetted opportunities spanning the broadest selection of alternative asset classes available.
The platform, on which nearly $4 billion has been invested to date, has a rigorous vetting process that includes screening each opportunity and prospective partner. The company’s exacting, structured, and holistic approach results in evaluations based on factors such as management team experience, track record, infrastructure, integrity, and overall approach.
Subsequently, the potential opportunity goes to Yieldstreet’s investment team, which assesses deal components, factoring in insurance policies, appraisals, market trends, and more. It then undergoes committee review to help identify possible risks. If all checks out, the opportunity makes the platform.
These offerings, which include real estate, art, and more, serve another crucial investor purpose: diversification. Building a portfolio composed of disparate asset types with varying degrees of risk can mitigate overall risk, which is essential to long-term investing success.
Alternative investments can be a good way to help accomplish this. Traditional portfolio asset allocation envisages a 60% public stock and 40% fixed income allocation. However, a more balanced 60/20/20 or 50/30/20 split, incorporating alternative assets, may make a portfolio less sensitive to public market short-term swings.
Real estate, private equity, venture capital, digital assets, precious metals and collectibles are among the asset classes deemed “alternative investments.” Broadly speaking, such investments tend to be less connected to public equity, and thus offer potential for diversification. Of course, like traditional investments, it is important to remember that alternatives also entail a degree of risk.
In some cases, this risk can be greater than that of traditional investments.
This is why these asset classes were traditionally accessible only to an exclusive base of wealthy individuals and institutional investors buying in at very high minimums — often between $500,000 and $1 million. These people were considered to be more capable of weathering losses of that magnitude, should the investments underperform.
However, Yieldstreet has opened a number of carefully curated alternative investment strategies to all investors. While the risk is still there, the company offers help in capitalizing on areas such as real estate, legal finance, art finance and structured notes — as well as a wide range of other unique alternative investments.
Moreover, investors can get started with a relatively small amount of capital. Yieldstreet has opportunities across a broad range of asset classes, offering a variety of yields and durations, with minimum investments as low as $10,000.
Robo-advisors — online platforms that offer automated investment services based on algorithms — are particularly popular with retail investors, since they are generally inexpensive and require relatively low opening balances. But they may not be the best choice for complex issues.
Remember, too, that there are other ways to invest that do not require in-depth market knowledge, and which can diversify one’s portfolio, to boot.
Yieldstreet provides access to alternative investments previously reserved only for institutions and the ultra-wealthy. Our mission is to help millions of people generate $3 billion of income outside the traditional public markets by 2025. We are committed to making financial products more inclusive by creating a modern investment portfolio.