Robo Advisors – Are they worth it?

Written by Taras Korytnyuk

On May 16, 2020
robo-advisors

What is a Robo‑advisor?

what is a robo advisorRobo-advisors are computer programs that automate the investment process. They use sophisticated computer algos to allocate assets in your portfolio based on your risk tolerance, age, and other criteria. 

How do Robo-advisors work?

  • First, they ask what risk a customer is willing to take. The software suggests a suitable investment, and then implements it for the customer. 
  • Determine risk type – users must first fill out a multi-part questionnaire and, provide information on their assets. They also have to state how many interim losses they could take – for example, in the event of a stock market downturn. 
  • Select asset classes – Robo advisor uses the risk category to determine which asset classes they divide the client money into. Asset classes are, for example, stocks, bonds, raw materials, or real estate. They often use rules that stem from capital market theory. Those who are more willing to take the risk of loss receive a portfolio that comprises equity funds. If you want to take less risk, more bonds added. This asset class generates hardly any interest, but causes the portfolio to fluctuate less. 
  • The implementation – they open a custody account for the customer, look for cheap equity funds (ETFs) and buy and sell them. ETFs are funds that replicate stocks and bond indices – sometimes commodity and real estate indices. 

Service costs

Many Robo advisors invest in low-cost ETFs. Their administration fee is often of the order of 0.3 percent per year. For the implementation of the investment, the service etc. There are extra fees. The surcharge varies from provider to provider and can range from under half a percent of the investment amount to more than 1 percent. 

Active versus passive Robo-advisors

Once the initial portfolio has been determined, the assistants differ in how they handle the investment for customers. 

Some take an active approach. This means that they redistribute assets between funds depending on what is happening on the stock market. The goal is often that losses are very likely not to exceed a certain value. This requires simulations – this in turn requires assumptions about the distribution of returns. Some providers also pay attention to the opinion of in-house analysts.  

Other Robo-advisors follow a passive approach. Its goal is to maintain the originally defined global asset allocation. Most of the time, providers reorganize assets a few times a year so that the original allocation to asset classes is restored (rebalancing). 

Robo-advisors can’t protect against losses 

Even if the Robo-advisor buys and sells securities for you: automated investment is not a guarantee to avoid investment risks. 

If the Market goes down or if interest rates rise, the price changes for stocks and bonds are also reflected in your portfolio. 

The investment assistants are responsible that the securities match your investment objectives. If you have answered the questions on these topics.

Who are Robo-advisors suitable for?

are robo advisors worth itOne thing is certain: a good investment does not need many tools. It doesn’t have to cost a lot either. We actually recommend that you take care of it yourself. But if you can’t or don’t want to take responsibility for the investment yourself, you should take a closer look at the service of a good Robo-advisor.

Do-Yourself-Investment (DYI)

The basic advice: invest part of the money in long-term in cheap, broad-based equity index funds (ETFs). Depending on your risk appetite – another part in fixed-term deposits or call money to absorb the fluctuations in the stock market. This DYI investment is cheap.  

 

You need for that

  • a cheap brokerage account
  • the necessary will power to stay in stocks during downturns.

 

Our calculations show: anyone who held a portfolio last 15 years, of 80 percent of the stock index and 20 percent of overnight money, never lost money.  

Automated investment

You can think about a digital investment assistant if you’d rather give up some of the responsibility for investing. 

So, if you:

  • need help in deciding how much risk you want or can take when investing
  • wish a specific suggestion on which ETFs to buy and how to combine them to reflect your risk appetite
  • want to hand over the technical implementation of your investment and
  • react emotionally during a stock market downturn. Robo-Advisors help you to maintain a portfolio once you have chosen it in the long term. 
  • you pay an extra for this “pick-by-hand” service compared to the self-made investment. The fee can range from a few tenths of a percentage point to a whole percent of the investment amount per year. 

Consider if the benefit of the Robo-Advisor is worth the money. Especially for a portfolio with a small number of shares. Robo-Advisor is more expensive than a DYI portfolio of overnight and fixed deposits. 

Which Types of Robo advisors are suitable for me?

Here we’ll explain how different types of Robo-advisors work.

Active Robo-advisors are not part of the consideration 

We do not currently consider the active Robo-advisors. Providers have to make many assumptions to be able to assess the risk of loss and to actively counteract it. The exact procedure is difficult to understand and test from the outside.

The active approach must first prove itself over longer periods of time. At best over an entire exchange cycle (downturn with later recovery).

Passive Robo-advisors tend to implement financial recommendations  

Robo-advisors that follow a passive approach are closer to the financial tip principles of investing. At the beginning: determine which asset classes the customer’s money should flow into. Bring the portfolio back to this initial breakdown once a year. Otherwise the portfolio follows the market, there is no further intervention. 

So we took a closer look at these passive digital investment assistants. To assess which providers are particularly good, we looked at several criteria. It was important to us: 

The providers that suitable for private investors, so they set the minimum investment amount at most $10,000.

The technical implementation of passive investments is done online and from a single source. For this reason, for example, we have excluded mixed funds.

Administrative and fund costs for $15,000 of money invested do not make up more than 1 percent of the total investment per year. The path to the self-made investment is otherwise too large in relation to the added value of service.

The providers put together a broad portfolio of clients that consists of cheap index funds (ETFs) and is not too defensive.

Not too defensive means: A digital investment assistant usually has to add cheap bond funds to the share part in the custody account. These bond funds depress the yield, but curb possible fluctuations – like time deposits. So a necessary evil.

 

By contrast, we do not consider an investment in commodity and real estate funds.

What else do you have to watch out for with Robo-Advisors?

When it comes to online investment, two questions arise: How can I open the account, and how long does it take? What do I have to consider for tax purposes? And: What happens if the provider – in this case – the Robo-advisor files for bankruptcy?

Opening account is very easy and can be done online in just a few minutes. 

The funds are safe and stored at a separate custodian bank that manages the assets. If the custodian also has financial problems, a trustee will take care of the fund’s assets.

Summary:

  • Robo Advisors use sophisticated software and algorithms to invest money. They invest in securities (usually index funds, ETFs). We also call them digital investment assistants.
  • Before you transfer money to the Robo Advisor, you need to answer questions about financial background and risk-taking. The investment assistant will then suggest a portfolio of securities.
  • Otherwise, you have minor work: the Robo-advisor opens and manages the securities account and buys and sells the securities for you.
  • Robo-advisors charge money for the service: an excellent provider keeps the total costs 1% of the total investment per year.

 

Good luck with your investments!

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