What is a Robo Advisor?
Simply speaking a robo-advisor is an algorithmic driven digital investment advisor. Traditionally traders used to go to humans to get advices on how to construct a diversified portfolio and provide financial advice. A robo-advisor instead relies on artificial intelligence, algorithms and academic portfolio theory to help you build and maintain a diversified portfolio. Similarly to traditional advisors also robo-advisors are fully regulated by FINRA and has to file quarterly SEC disclosures. Follow our guide and you will get introduced to robo-advisors and their role in the current investment world.
What robo-advisor is the best?
When choosing an investment advisor in general there are a number of things that you need to consider. Below we have listed some top criteria to look up
What are Management Fees for Robo-Advisor?
This is the fee that you have to pay every year to have an account at a robo-advisor. That cost which is normally a percentage of your assets is normally taken from your account balance.
Why it is important? Any costs that you incur like the robo-advisor management fee will reduce your return. If you are making an earning of a 7% on your portfolio in one year and you are paying a 0.25% annual management fee your profit will be effectively 6.75%. Taking account of every small fee is really important as everything adds up over time.
What are expense ratios in Robo-Advisor?
This are similar to the robo-advisor management fees with the only difference that are not paid to the robo-advisor but to the investments that are used by the robo-advisor. Index funds, exchange-traded funds etc. all charge an annual fee to cover the costs of running the fund.
Why it is important? Similarly to the robo-advisor management fees those are costs that will eventually hit your margin at the end of the year. As an investor you can’t avoid to pay expense ratios even if you don’t use a robo-advisor. It is important however to try to pick robo-advisor that uses low-cost funds. In order to find out the best deal you should take a look at the average mutual fund expense ratios that will tell you if you are actually paying too much.
What investment accounts the Robo-Advisor manages?
We have two types of investment accounts:
1 – Retirement accounts – those are like IRAs and 401(k)s. Those type of investments normally offer tax advantages for contributions and have rules that regulate how much you can contribute and when.
2 – Nonretirements accounts – those are also known as taxable accounts and there are no specific tax benefits for contributions to those but they are normally not subject to contribution limits or other similar rules.
Why it is important: when picking a robo-advisor you need to ensure that it manages the kind of account you want to open. You should also look at which features mostly apply to you.
What type of investments you can make with a robo-advisor?
The majority of robo-advisors use low-cost index funds and ETFs.
- Index funds: this is a mutual fund that passively tracks and index or benchmark. For example a Standard & Poor’s 500 index fund tend to mirror the performance of the S&P 500
- ETF: similarly to an index fund, an ETF holds many individual investments and also track an index or benchmark. The biggest difference is that ETF’s trade on an exchange similarly to individual stocks and can normally be purchased for a lower investment compared with a traditional fund.
Why it is important: you need to ensure that the advisor you choose will offer the investments that you desire and also that those investments are low cost. There are few robo-advisors that also add in actively manages mutual funds and individual stocks. Others do also customise completely your portfolio.
What is Tax-Loss Harvesting and how the Robo-Advisor can help you?
Tax-loss harvesting is about selling losing investments and using the loss to reduce or completely eliminate the taxes you will own on capital gains. The IRS has lots of rules tough and it’s a really good if a robo-advisor will do it fo you.
Tax-loss harvesting can be difficult to do with the fund portfolios that are used by lots of robo-advisors. Some robo-advisors buy individual stocks to replicate an index and by doing that allows them to sell specific losers.
Why it is important? it might not be important as tax-loss harvesting doesn’t apply to retirement accounts as there taxes are deferred and there is no capital gains taxes. For taxable accounts tough you might save a lot of money.
What is rebalancing and how Robo-Advisor can help you?
Market fluctuations can mix up the investments that you hold. Rebalancing will allow you to get back to the original mix. Lots of robo-advisors will check for rebalancing opportunities every day and will make portfolio changes when an allocation will stray let’s say by 5% or more.
Why it is important? if an asset class is doing well you could finish up with more of your money in that class that you firstly planned. This will be due to outsize growth. If your initial allocation was for example 50% stocks and 50% bonds than if a portafolio has moved towards 70% stocks it is becoming probably too risky. In this case the robo-advisor will help you rebalancing your portfolio.
Why it is important to also have access to human advisors?
A robo-advisor can surely be doing a great job however a bit of human interaction is also suggested. Most robo-advisors have in fact merged computer-driven portfolio management with also access to human financial advisors. You can have different level of assistance: some will offer a dedicated advisor to individual clients while other will just offer email or online chat with a team of advisors. Normally those are offered at extra charges.
What is socially responsible investing and how does affect the choice of robo-advisor?
This strategy is also called SRI and it is employed by those traders that are trying to align their investments with their values. Companies that promote social good are usually being included in SRI portfolios while others that are active in controversial industries like guns or fossil fuels will be normally excluded.
Why it is important? If you are adopting a socially responsible investment strategy than you should choose a robo-advisor that allow investments that meet those standards.