What is Robo Investing?
Robo investing involves investing with a “robo advisor,” which are digital platforms that make it simple for investors to build diversified portfolios.
June 23, 2022
This article is provided for informational purposes only and should not be construed as legal or investment advice. Always consult with a professional financial or investment advisor before making investment decisions.
Investing is vital for building long-term wealth, but it can be a confusing world. There are many different investment platforms and thousands of investment options. Where do you begin?
New investors may wish to utilize the latest technology to make investing easier or more efficient. “Robo advisors” may play a role in this.
What is “robo investing,” exactly? This guide will explore the trend of robo advisors and robo investing to see if it may be a good fit for you.
What is robo investing?
Robo investing is the process of investing with a robo advisor. In this case, robo is short for robot and refers to a digital advisor instead of a traditional human advisor.
Essentially, robo advisor platforms seek to mimic some of the services of a traditional wealth manager or a financial advisor. Investors can sign up for these platforms and gain access to automated tools to improve the efficiency and diversification of their portfolios.
Examples of top robo advisors include:
There are several other platforms in this space. Each offers somewhat different benefits, services, and costs, so it’s wise to explore all your options.
What do robo advisors do?
Robo advisors provide a few benefits. For one, they can simplify investing for beginners.
You can sign up, answer a few questions about your investment philosophy, risk level, and goals and get started right away. The robo advisor will recommend a prebuilt portfolio of investments, and you can simply deposit money and immediately have a diversified portfolio.
There are other perks for more advanced investors, as well.
Robo advisors can automatically rebalance portfolios, for instance. This means that you can set your portfolio to invest in 50% stocks, 30% bonds, and 20% real estate. If your portfolio drifts to 51% stocks, 29% bonds, and 20% real estate, the robo advisor can automatically buy and sell assets for you, returning you to your desired allocation.
Another perk of some robo advisors is that they can potentially help investors minimize the effects of capital gains taxes. Through a process known as “tax-loss harvesting,” some robo advisors can sell assets that are currently at a loss to offset gains from other investments. This could potentially reduce your tax bill.
All of these processes certainly can be achieved on your own; investors can design diversified portfolios, rebalance their asset allocation and conduct tax-loss harvesting.
The benefit of robo advisors is that they do these things automatically and without investor involvement.
Can help simplify investing for beginners
May provide advanced tools for making investing more efficient
Might help reduce taxes
Can automatically rebalance portfolios
Useful for adding diversification to your portfolio
May add an extra cost (usually 0.25% to 0.5% per year)
Typically not designed for active trading
Might not offer all asset classes or investment products
Could have account minimums ($1,000 minimum, for example)
May be limited by account types
Robo investing vs. traditional investing
With traditional investing, investors sign up for a brokerage account at somewhere like Schwab, Fidelity or Vanguard — or through an investment app like Robinhood.
From there, they can manually pick and choose any assets that they want to invest in. They can buy individual stocks, index funds, bonds and much more.
Traditional investing is entirely self-directed. The investor makes all investment decisions and all the trades.
With robo investing, more elements are automated.
Most robo investors recommend prebuilt portfolios based on asset allocations and risk levels. For example, they may have a prebuilt portfolio that invests 80% in U.S. stocks and 20% in U.S. bonds. When the investor selects that portfolio, any money deposited into their account will automatically be invested in those assets.
Overall, investment returns depend on the mix of assets that an individual invests in — whether that’s through a robo advisor or a traditional brokerage account.
To compare returns, we must conceptualize two portfolios with identical asset mixes: One held at a robo advisor and one at a traditional brokerage firm. Which one would perform better?
Theoretically speaking, the robo advisor would likely deliver slightly higher returns — although this depends on the fees the advisor charges.
The reasons for slightly higher returns are:
Tax-loss harvesting: By minimizing the effect of investment taxes, robo advisors may be able to improve post-tax returns. Wealthfront data suggests that its typical client boosts their post-tax returns by around 1.8%.
Automated rebalancing: Rebalancing a portfolio can also produce a slightly higher rate of return because it automatically sells a small number of assets when their prices increase and buys others when their prices decrease. This effect is small and there’s no clear data on the return advantage.
Any return boost that robo advisors provide will be reduced by the cost to use the platform, known as the management fee.
Costs of robo investing
What does robo investing cost the investor? Usually, it’s a simple annual fee that’s a percentage of the assets under management. For most advisors, this fee ranges from 0.25% to 0.5%, but it may be higher.
This means that if you’ve invested $10,000, you’ll pay between $25 and $50 per year. If you’ve invested $100,000, the fee will be between $250 and $500 per year.
These fees are subtracted from your investment performance automatically. You won’t “pay” them out of pocket but they will decrease your investment returns. If you earn 10% returns in a year and there’s a 0.5% fee, you’ll only earn 9.5%.
None of this sounds too bad but remember: These fees are charged every year, even if you lose money. The market could go down 20% and the robo advisor would still charge you a fee.
In the long run, fees can have a huge effect on investment performance. The question with robo advisors is if the benefits they offer outweigh the fee they charge.
Robo advisors provide enhanced automation to the process of investing. They can be useful for beginners looking to simplify the initial stages of investing, as well as for experienced investors looking to take advantage of advanced tools.
These services charge a fee, however. It’s up to individual investors to decide whether a robo advisor makes sense for their situation.
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