A robo-advisor is an automated financial and investment advice service. It is a programme that uses algorithms to present investment portfolios to users. The allocation of assets within the portfolio is based on parameters that the user is asked to enter, typically by filling in an online form. Aspects to be entered into the form include the investor's investment objectives, risk profile and personal preferences (e.g. thematic or sustainability).
Once the user has entered the required information (return objectives, risk tolerance, thematic preferences, sustainability, etc.), the programme generates an investment portfolio. At this point, if the user considers the portfolio to be suitable for his or her needs, he or she can start investing: he or she pays in capital (often via his or her bank account) and then creates a custody account based on the allocation proposed by the algorithm. Investment activity then begins, which must be monitored regularly, although the investment plan is usually monitored by the software or the managers themselves to ensure that it remains in line with the user's instructions.
The automation of asset allocation and investment makes robo-advisers cheaper than human advice. According to CNN Underscored Money, robo-advisor fees range from 0.15-0.50 per cent (commissions are often reduced through the extensive use of ETFs). They also have lower average access thresholds, i.e. lower amounts that need to be deposited into the investment account, than personal advisers.
The absence of a live advisor can be an advantage in terms of cost, but also a limitation when considering the combination of each investor's financial and psychological needs on the one hand, and the availability of investments on the other. As we also read on CNN Underscored Money, the advice of a professional is usually more functional in the case of articulated assets or multiple needs (so not only investments, but also areas such as financial planning, estate management, tax advice, inheritance issues, etc.).
It should be noted that platforms offering robo-advisory services often combine automated programmes with the possibility of using a human advisor. In other words, many robo-advisory service providers can offer users a so-called hybrid approach, i.e. an approach that combines the efficiency of algorithms for portfolio construction with the added value of personalised financial advice.
The investment and asset allocation recommendations of robo-advisors are based on algorithms that are typically inspired by the Modern Portfolio Theory developed by Harry Markowitz. According to the theory, the software maximises expected returns for a given level of risk. In other words, it optimises the combination of assets to be included in the portfolio, diversifying the investments so that the choice of securities is as close as possible to the parameters specified by the investor.
Read also
What are ETFs and how do they work?
Why does it make sense to diversify your investment portfolio?
From the glossary
