The Ultimate Guide to Robo-Advisors

The inception of the automation era has opened doors to unimaginable stretches of human possibility. Today, automation has transformed financial investment into a profitable concept by leveraging returns at a comfortable level of risk. Traditionally, investors relied on vast investment experience and efforts to manage their financial portfolios. Thankfully, the modern automated portfolio builders, popularly known as Robo-advisors, are here to offer investment solutions at reduced costs and minimal human effort. Robo-advisors are swiftly taking over the financial investment landscape. They are expected to continue to be used in the future. So, what are they, and how do they work? This guide features everything that you need to know about Robo-advisors.

What are Robo-Advisors?

Robo-advisors or Robo-advisors are financial investment platforms that rely on algorithms to automate financial management services. With Robo-advisors, investors can create investment portfolios and obtain financial planning solutions with minimal or no human effort. Essentially, you will not require a portfolio manager or financial adviser to generate an investment plan.

Generally, a Robo-advisor will collect your data through your online Robo-advisor account. Consequently, the algorithm-driven digital platform will analyze your financial status and investment goals through an online review. The analysis results are then employed to tailor advice for your portfolio and make the necessary investment moves.

Most Robo advisors are accessible on mobile devices and over the web. Whether you are a newbie or an experienced investor, a Robo advisor will help you invest your assets and offer guidance along the way. All you need is a Robo Advisor account and investment funds to enjoy a wide range of services, including portfolio building, portfolio allocations and maintenance, dividend reinvestment, and other account services.

How Robo-Advisors Work

Once your Robo Advisor Account has been set up, you will be required to complete an online survey where you provide data about investment goals and risk tolerance capabilities. Using the collected data, the Robo Advisor platform generates a diversified portfolio with assets like bonds, stocks, and REITs.

Robo-advisors use what is commonly known as Modern Portfolio Theory (MPT). This is a passive investment strategy that focuses on appropriate asset allocation rather than selecting individual assets for investment. The MPT indexing strategy is known to minimize risks while leveraging returns.

Typically, the generated portfolio will hold as many as 12 classes of different assets. In effect, your Roboadvisor will assign a sole Exchange Traded Fund (ETF) to each of the featured asset classes. You can then transfer or deposit your preferred financial investment into your account. Consequently, your Roboadvisor platform will apply financial algorithms to allocate every asset class across a wide range of portfolio investments.

While selecting and allocating funds to every security may vary with different investors, these investments are generally low-cost. Cost-effectiveness, low fees, security features, portfolio management, and varied account services are factors that make Robo-advisors a suitable choice for investors.

Features of a Robo Advisor

The following features define a typical Robo advisor.

Tax-Loss Harvesting

Robo advisors are known for applying the tax-loss harvesting strategy as a way of optimizing your portfolio for minimized tax liability. In this case, a Robo advisor will sell off the losing investments to cancel out capital gains taxes. When choosing a Robo advisor, it is crucial to analyze the fees charged for this service. Some Robo-advisors offer the tax-loss harvesting service at zero cost, while others charge an extra fee for the same feature.

Automatic Rebalancing

This financial management tool is designed to adjust your investments to fit your specific financial goals and allocation preferences. In most cases, a Robo advisor will sell off the appreciated assets to earn some profits. In return, the generated profits are reinvested into asset classes that are out of favor. Simply said, automatic rebalancing is a way of keeping your portfolio in check to achieve your stated investment goals.

Dividend Reinvestment

Your Robo advisor may evaluate the dividends paid out by various securities then determine the best ways to put the money back to underlying or other assets. This is well known as dividend reinvestment. The focus is to avoid holding funds that are not generating returns on your investment.

Automated Investing

This is one of the most definitive features of a typical Robo advisor. Automated investing allows the digital platform to schedule funding across your portfolio without any instruction from you. Essentially, the Robo advisor decides on what investments to allocate to your portfolio.

Multiple Services

The growth of the Robo advisory industry has seen more services gain traction within these digital platforms. Today, you can access an array of banking services within the same channel, including personalized financial planning, unlimited withdrawals, goal-based accounts, and cash management accounts.

How Taxation Works with Robo Advisors

When it comes to taxation with Robo advisors, how much you incur is totally dependent on the type of investment account holding your assets. For instance, you may only incur a tax liability when you withdraw money from any tax-deferred retirement account, including the Individual Retirement Account (IRA) and Roth IRA accounts. This may not include asset transfers and rollovers as they are not considered to be withdrawals.

On the other hand, holding assets on taxable and brokerage accounts may require you to report taxes on your earnings and make the necessary tax returns. In the event of a sale of investments from a Robo-managed account, the capital gains tax liability is realized.

The Fees and Costs of Investing with a Robo Advisor

Some Robo advisors will charge you a fixed monthly subscription fee for the services rendered. On the other hand, you may be required to pay an annual management fee calculated as a percentage of your assets. Usually, the annual fee ranges from 0.15% to 0.5% of the total assets under maintenance. However, these costs are separate from all the charges incurred by specific assets. For instance, investing in Exchange Traded Funds (ETFs) may incur a separate charge which is not included in the costing of a Robo-managed account.

Robo advisor platforms are generally cheap and low-cost. An investment with a Robo advisor costing you about 0.25% of your assets may generate a maintenance fee of about 1% of the same assets when investing with traditional financial advisors. Also, it is essential to note that Robo fees tend to compound over time, resulting in higher fees in the long term.

The Pros and Cons of Hiring a Robo Advisor

Hiring Robo advisors comes with benefits and risks in equal measure. Here is a highlight.

Pros

Low Cost

Robo-managed accounts are generally cheaper and more cost-effective than traditional financial advisors. Some Robo advisors offer free services to a certain extent, while others charge you as little as 0.15% of your total assets. This means that with only $15, you can have a $10000 investment account managed. There are also zero commissions when trading with the account. The one-time fee paid at the start of your investment is all you need to have all your expenses covered.

Reduced Minimum Investment Requirement

With traditional financial advisors, investors are required to have a specified minimum investment to get advisory and investment management services. However, when it comes to Robo advisors, there are often no minimum investment requirements. The few digital platforms with these threshold demands will require you to have as low as $500 initial investment to receive their services. Again, the use of ETFs in Robo investing makes it possible for you to spread a small investment across thousands of assets.

Accessibility and Ease of Management

Robo investing guarantees 24/7 access to your Robo-managed account via a mobile phone or over the web. You can easily check on your investment status at any time, enhancing easy management of your portfolio.

Educational Resources

There is no better way to gain experience and expertise in financial and investment management than to acquire the necessary skills and information. Almost every Robo advisor features educational tools and resources to keep you up to date on the dynamics of finance.

Tax Efficiency

Robo-advisors are generally a tax-efficient method of investment. Strategies like tax-loss harvesting offer an opportunity to leverage returns while minimizing capital gains taxes.

Cons

Limited Investments

There is a limitation as to the types of accounts you invest with a Robo advisor. Most of these digital platforms limit you from including such account types as custodial and joint accounts.

100% Automation

Robo advisors are 100% automated platforms designed to make investment decisions on your behalf. While this is beneficial to newbies and inexperienced investors, you do not have the liberty to make your own investment choices.

Lack of Financial Advice

One popular setback of investing with Robo advisors is their lack of capacity to offer financial advice to investors. Although some platforms link you to an expert for technical guidance, they may not necessarily give you the investment advice you are looking for.

How to Hire a Robo Advisor

Fortunately, today, there are plenty of Robo advisor options available online. You can get Robo-advisory services anywhere at any time. Here is a step-by-step guide on how to hire the best Robo-advisor.

Step 1: Know What You Want

Your investment goals should inform your choice of a Robo advisor. Today, Robo-managed accounts come in two options, including the fully automated and hybrid Robo advisors. The latter gives you access to both algorithm-based and traditional financial planning services. On the other hand, the former limits your involvement in choosing the various investment options.

Step 2: Explore a Robo Advisor via Free Trial Offer

Most Robo advisors provide you with a free trial offer, making it easy for you to explore their services before subscribing to a paid membership. This way, you can determine the value of a platform before putting your money in it.

Step 3: Scrutinize Your Robo Advisor

Scrutinizing and rating a Robo advisor enables you to pick the best option in the market based on certain factors. For example, you want a platform that possesses the following;

Low Costs

Check out for such costs as subscription fees, transaction charges, upfront costs, and commissions before committing to a Robo advisor. The cost of getting a Robo-managed account may be higher than the initial deposit of investment.

Reputation

With almost no barrier to entry, there is a wide range of Roboadvisor options available in the market today. However, you want to invest your money with a trustworthy platform, which is why you must establish a company’s reputation prior to choosing one.

Service Offerings

Check out the type of financial services you will get from a Robo advisor before picking your option. It is the Robo-advisor that offers a mix of portfolio management services that should be worth your investment.

The Best Robo-Advisor Services in the Market

Here is a list of some of the top-performing Robo-advisor platforms in the market.

Wealthfront Robo Advisor

Founded in 2008, Weathfront is one of the oldest and largest Robo advisor platforms in the US. The company provides highly diversified portfolios, which include bonds, stocks, natural resources, and real estate. Wealthfront has a specialty in tax-loss harvesting for taxable accounts exceeding $100,000.

The company’s minimum investment is $500 and 0.25% annual advisory fee. You can use Wealthfront via phone or over the web.

Betterment

This is probably the largest Robo advisor in the market today. Betterment is credited for being the first Robo advisor to introduce various specializations, including Smart Beta and tax-loss harvesting. Betterment’s basic account gives you access to the company’s services with zero minimum investment and a 0.25% annual advisory fee.

Betterment stands out as one of the few Robo advisors offering accounts for trusts, IRAs, joint, and individual taxable accounts.

M1 Finance

M1 Finance exists as a hybrid Robo advisor. The platform allows you to create an asset class known as Pies, which includes portions of individual stocks and ETFs. A single Pie can hold up to about 100 securities, and investors can create as many Pies as they wish.

M1 Finance has zero minimal investment requirements and no annual advisory fees.

Axos Invest

Axos Invest was launched in 2013 as a free-service Robo advisor. There is also no annual advisory fee, and investors do not require any minimum investment to get started with Axos Invest. However, Axos Invest requires you to pay an extra fee for any taxable account.

Wrap up

Robo investing is an excellent option for individuals with minimal or no experience in financial investments. It is a convenient way to grow your wealth with almost no involvement on your part. However, you can always consider a human financial advisor when you are stuck with navigating your financial projections.