An automated investment manager, or “robo-advisor,” is a wealth management tool that utilizes software to develop and execute investment strategy. Based on algorithms and mathematical presets, it was popularized in 2010 with the advent of the company Betterment and has since grown to around 500 billion in assets under management worldwide. So what makes this type of investing so popular, and what are some of the benefits of using a robo-advisor instead of a traditional financial planner?
One of the many benefits of the digital age is ease of use, and automated investing is no exception. Getting started with a robo-advisor is simple and fast, where account setup generally involves a straightforward set of questions designed to assess your financial situation, goals, and risk tolerance. Based on your answers, the software then generates a suggested asset allocation you can then approve or adjust. Robo-advisors can also let you get started investing even if you don’t have a huge nest egg. While traditional financial planners can have high barriers to entry (sometimes $250,000 or more), you can get started with many automated investment strategies with low or even no deposit minimum.
Fees and Ease of Use
With algorithms doing the heavy lifting, the cost of automated fund management is low. Compared with traditional commissions that will set your portfolio back anywhere from one to three percent per year, fees for automated investment funds usually run between one-quarter to half a percent. Additionally, robo-advisors are consistently and quickly accessible online or through apps – meaning you can check up on your portfolio’s performance, track your goals, and even make changes such as update your risk profile at any time.
Automated Tax-Loss Harvesting and Portfolio Rebalancing
Tax-loss harvesting is just what it sounds like – at the end of the year, any investments in the red are sold off and the losses used to offset gains, resulting in a reduced tax obligation for the year. While financial planners can do tax harvesting, most robo-advisors include it automatically or make it simple to opt-in. Likewise, because of their technological capabilities, robo-advisors also often offer more frequent – sometimes even daily – portfolio rebalancing. This means buying or selling assets in order to maintain the original weighting of your portfolio, ensuring asset allocation remains consistent and maintaining your preferred risk tolerance.
Taking Emotion Out of the Equation
Most investing strategies do best when left alone. Research has repeatedly shown that because of something called behavioral economics – or the ways in which people let their emotions affect their investment decisions – even the most experienced human managers can let market movements tempt them into overtrading a portfolio. Investing is inherently emotional, and adopting a more passive strategy through indifferent mechanical mechanisms that stay focused on the long term picture rather than short term price movements can mean the difference between underperforming the market or maintaining a comparable rate of return over time.
For many in the technological age who want a way to invest with easy access, low fees and greater consistency, automated investing can be a great choice. Certain situations will always (or at least, for a long time yet) require a human touch. For example, if you want to know how to prepare for homeownership, invest in a business, or start setting aside money for a college fund, you’ll want to sit down with someone face to face. However, as machines and technology make other tasks easier, faster, and cheaper, tools such as automated investing may provide better options versus their traditional counterparts.