What is a Robo Advisor? A Beginner’s Guide to Automated Investing

There was a time when investing meant having substantial wealth, deep financial knowledge, and the time to manage your portfolio actively. That landscape has changed. With the rise of digital platforms, technology is making wealth-building more accessible. One such innovation is the robo advisor.

Robo advisors are automated investment platforms that use algorithms to manage your money based on your goals and risk profile. They aim to simplify investing by reducing the need for manual intervention or financial expertise.

This beginner’s guide explores what is robo advisor, how it works, the advantages and limitations of using one, and whether it suits your investment approach.

What is a robo advisor?

A robo advisor is an online investment platform that manages your portfolio by using algorithms. It offers automated advice on financial planning and investments with little to no human intervention. You will be required to fill out a questionnaire about your financial goals and risk tolerance to create an investor profile. Based on the data received, the tool will create an investment portfolio tailored to your needs and automatically invest on your behalf.

How do robo advisors work?

Let’s understand how robo advisors typically work:

1. Onboarding survey: After signing up for robo advisor services, you will be asked questions about your age, gender, income, financial goals, risk tolerance, investment timeline, and how long you plan to maintain your investments.

2. Portfolio creation: Based on your responses, the tool will use algorithms to create a diversified portfolio—bonds, stocks, ETFs (exchange traded funds), real estate, etc.

3. Investing: The robo advisor will automatically invest your money based on the fund allocation.

4. Ongoing management: The platform will manage your investments by continuously monitoring and rebalancing the portfolio to make sure it is aligned with your target asset allocation.

5. Additional features: Some robo advisors come with extra features such as retirement planning, risk profiling, tax-loss harvesting, etc.

Benefits of using a robo advisor

Robo advisors have several benefits, such as:

• Low cost: Compared to traditional investment methods, robo advisors typically charge lower fees as they rely on technology and algorithms. The online platform offers the same services at a much lower cost because it eliminates the need for human advisors.

• Accessibility: Digital tools like robo advisors can be accessed from anywhere and at any time. This means you can check and manage your portfolio anytime and from any place with an Internet connection.

• No financial expertise required: Even if you are not a financial expert or if you have no prior investment experience, you can still start investing because robo advisors will manage your portfolio. This is particularly helpful for beginners in investing.

• Efficient: Before robo advisors and online brokerage accounts, if you wanted to execute a trade, you would have to call or meet with a financial advisor, explain your needs, and wait for them to manage your trades. Robo advisors can do all these with just a few clicks.

• Low minimum investment: You don’t have to be super rich to begin any investment. If you have a tight budget, you can still get started because robo advisors require low or no minimum investment amounts. You can begin investing with as little as ₹500.

Limitations of robo advisors

Some of the limitations that you must be aware of before choosing robo advisors are:

• Lack of human interaction: Due to minimal human interaction, robo advisors are drawing flak for lacking empathy and emotional intelligence. They cannot provide emotional support, guidance, and personalised advice, particularly when the market is volatile or when you have to take a critical financial decision. This is where human advisors have an edge over automated investing.

• Limited customisation: Although robo advisors can help personalise diversified portfolios based on your financial goals and risk tolerance, they have limited flexibility when it comes to customisation. For instance, they may not allow you to choose individual stocks, or exclude some sectors or companies.

• Not ideal for complex portfolios: A robo advisor is a good option for beginners or small investments. However, they cannot provide comprehensive financial planning services, including retirement planning, estate planning, complicated tax management, or trust fund administration.

• Tech dependence: If you depend solely on automated tools like robo advisors for investments, you cannot make buy or sell decisions based on your own insights or market opportunities. You have less control compared to working with a traditional advisor.

How much do robo advisors cost?

The cost of using a robo advisor typically includes two components: management fees and expense ratios. The annual management fees charged by most robo advisors depend on a percentage of your assets under management (AUM), which usually ranges from 0.25% to 0.50%. This is significantly lower than the fees charged by traditional financial advisors, which are 1-2%.

Apart from management fees, you have to pay the expense ratios of the funds included in the investment portfolios. For low-cost ETFs, the charge is less than 0.1% per year.

Conclusion

Whether you are new to investing or someone looking for a hassle-free way to grow your wealth, a robo advisor is a wise choice. It is a simple, easy-to-use, and cost-effective way to manage your portfolio using algorithms automatically. Robo advisors will analyse your financial goals, risk tolerance, and time horizon to create and manage a diversified investment portfolio.