Investing can be intimidating, especially when you don’t have much experience. Some people rely on private bankers or stock brokers – who don’t always have their customers’ best interests in mind. Some people choose to invest on their own, and to learn along the way. One alternative between the two is a “robo-advisor”.
A robo-advisor is an online wealth management service that uses mathematical formulas called algorithms to develop, maintain and rebalance your investment portfolio. You go online and fill out a questionnaire that will help determine your investment goals and the level of risk you’re comfortable with. Based on this information, the program builds a portfolio, similar to how a private banker or stock broker would, to reflect your stage of life, assets, time horizon and objectives. Because the process is automated and uses very little human input, it’s been given the “robo-advisor” nickname.
As part of building the portfolio, the algorithm ensures that your investments are optimally diversified – or spread across different assets to reduce overall portfolio risk. Algorithms also rebalance the portfolio, so that if one holding does a lot better or worse than the other investments, the program will automatically buy or sell to make sure your portfolio stays in line with your goals and risk tolerance.
Robo-advisors offer sound and objective investment advice for a fraction of the price you’d pay a human advisor. For instance, Nutmeg is a popular robo-advisor and charges an annual management fee of 0.3% – 1% of assets managed, compared to the 1% – 3% that traditional advisors charge.
Robo-advisors also take the emotion out of investing. They’re the closest thing possible to real psychopath investing. Even (or especially) experienced financial professionals can fall victim to biases that can lead to faulty decision-making, such as confirmation bias, expectation bias and status quo bias. Robo-advisors have no biases and make investment decisions based only on numbers.
Robo-advisors are also a good option for individual investors who are starting off with a relatively small amount of money. Some, like Wealthfront – one of the biggest robo-advisors – only require US$500 to open an account; Nutmeg, mentioned earlier, requires GBP 1000 to start. Even low-end private bankers and brokers often won’t glance your way unless you have at least several hundred thousand dollars to invest.
Robo-advisors primarily invest in exchange traded funds (ETFs), and occasionally index funds (which track a market index such as the S&P 500 or the STI), and individual stocks. These provide exposure across a broad range of asset classes including equities, bonds and commodities from all over the world. Often, there is a small additional fee charged by the ETF, typically around 0.1% – 0.2%.
There’s one thing you do miss out on with a robo-advisor, and that’s the opportunity to learn more about the investment process through experience. For some investors, that might be a plus. Asking a robot to do all the work can take the stress out of managing your money.
Or the idea of leaving your money in the care of a computer program might make you feel uncomfortable. There are hybrid alternatives that might be appropriate, depending on how much human contact you’d like. Some robo-advisor companies have human representatives available to answer questions and deal with any problems. Investment decisions are still made based on algorithms, but you can ask for the human touch when you need it.
Robo-investing is still in its infancy, but the options for investors are expanding and becoming more targeted. For example, this year companies such as Ellevest and WorthFM will be offering services that target women who have gender-specific financial considerations, such as planning for maternity leave.
Most of the growth in robo-advice has been in the U.S. and Europe so far, although some are being established in Asia. Hong Kong-based robo-adviser 8Now!, for example, was set up last year and is available to Hong Kong and Japanese investors with a minimum $10,000 initial investment. And Singapore-based private banker Infinity Partners has launched their own robo-advice service for wealthier expats. Some big banks will probably launch their own robo-advice services too, as a way to funnel investors to their private bankers.
Robo-advisors will not totally replace private bankers or stock brokers. And a lot of people will continue to want to learn about investing on their own, and to be in charge of their own finances. But robo-advisors are an option for investors looking to save money on fees, and who prefer a hands-off approach to investing.