Robo advice is giving Australians an easy and affordable option to invest and build wealth. But what is a robo advisor and how does robo advice work? Here’s a quick guide on what you need to know about robo advisory services, and how they are reshaping the investment landscape in Australia and around the world.
Table of Contents
- What Is a Robo Advisor?
- How Do Robo Advisors Work?
- Types of Robo Advisors
- Robo Advisors Pros & Cons
- Best Robo Advisors Compared
- Robo Advisors Bottom Line
What Is a Robo Advisor?
A robo advisor makes recommendations on how to invest your money using sophisticated technology. This automates many of the tasks manually performed by a human financial advisor such as understanding your appetite for risk, recommending a mix of investments, and regularly rebalancing your portfolio.
In this way, a robo advisor provides significant cost savings for investors, which means more of your money goes towards building wealth. A robo advisor also saves you time as your portfolio can be up and running in a matter of minutes without the need for lengthy meetings with a financial advisor.
How Do Robo Advisors Work?
Each robo advisor service will have its own approach, but the common thread is that they all follow three main steps:
1. Complete a Questionnaire
Your robo advisor will ask you to fill out an online questionnaire. This addresses factors such as your age, personal goals and how you feel about risk.
It doesn’t take long to complete the questionnaire, but it’s important to answer accurately as your responses will shape the investments recommended for you.
2. Automatic Portfolio Generation
Using the data provided by the questionnaire, the robo advisor will suggest the investment portfolio best suited to your needs, aspirations and tolerance for risk.
The portfolio is often comprised of a basket of exchange traded funds, which offer substantial diversification with very low fees.
3. Expert Monitoring
With your portfolio up and running, the robo advisor will monitor your investments, and automatically rebalance your blend of assets so that your portfolio continues to match your needs, lifestyle and your goals.
Types of Robo Advisors
Robo advisors can be broadly categorised using the three dimensions outlined below:
1. Technical Competency
Simplistic robo advisors use a conventional style of investor profiling. In practice this means relying on an individual investor’s responses to a questionnaire, and analysing this data to get a good picture of the investor’s risk profile in order to recommend the appropriate investment portfolio.
Comprehensive robo advisors go a step further, often using artificial intelligence (AI) to gain an evolving picture of an investor’s spending behaviour and likely responses to various situations. This allows the robo advisor to pinpoint the most appropriate investment portfolio for each investor’s profile.
2. Revenue Structure
Robo advisors in other parts of the world may be able to charge commissions for selling specific investment products. But Australian robo advisors (and human advisors) are not permitted to charge a commission on superannuation products and ordinary investments.
Robo advisors typically earn income by charging an advisory fee. This may be a flat monthly fee or it can be based on a percentage of the value of your portfolio. As fees differ widely, it is important to shop around between robo advisors to be confident you’re getting value for money.
Exchange Traded Funds Only
Many Australian robo advisors offer a portfolio of investments made up of varying blends of exchange traded funds (ETFs). As we’ve noted, ETFs offer the advantage of considerable diversification combined with very low fees.
Wider Class of Assets
Your robo advisor may also offer access to a broader choice of assets including cash, as well as Australian and global shares, and even cryptocurrencies.
Robo Advisors Pros & Cons
There are advantages and drawbacks of using robo advisors. Here are the main issues to weigh up.
Robo Advisors Pros
1. Low Fees
The services of a robo advisor will cost a fraction of what you would expect to pay a human advisor. Some estimates suggest the cost of robo advisors works out to be one-tenth the cost of traditional advisors. This makes robo advice an affordable option for all investors.
2. Easy Access
If you have access to Wi-Fi, you have access to a robo advisor! There’s no need to plan ahead, make an appointment, then spend time in an office with an advisor. Getting started with robo advisors and tracking your investments can be done from your own home at a time that’s convenient for you.
3. No Human Bias
All humans have biases that we’re often unaware of. Yet these biases can see investors (and even human advisors) make decisions that deviate from an investor’s long term goals. Part of the appeal of robo advisors is that your portfolio is put together and managed by algorithms that are free from biases and emotion.
4. Comprehensive Services
Robo advisors offer a growing range of services. This may include wealth planning, or investing for special purposes such as your child’s education, or investing via a self-managed super fund. In addition, robo advisors are increasingly meeting the needs of investors who want to invest in line with their views around ethics and sustainability.
Robo Advisors Cons
1. Limited Access to Human Advisors
Robo advisors do have contact points where you can speak to a human. However, some investors prefer to regularly speak with a human advisor, particularly during periods of market turbulence.
2. Narrow Investment Choices
For the vast majority of investors, the investment choices offered by robo advisors are more than ample. But if you are looking for specific niche investments, they may not be available through a robo advisor.
3. Limited Flexibility
As an investor you may be looking for the flexibility to regularly change your investments, reshape your portfolio, or re-set new goals. Robo advisors may not offer the level of flexibility to do this.
Best Robo Advisors Compared
Robo Advisors Bottom Line
The ability to have a personal conversation with a human advisor will always be a critical aspect of choosing an advice service for some investors.
However, if you are looking for a streamlined investment option that is low cost, easily accessed and free from human bias, robo advisors can offer an affordable solution that helps you achieve a variety of goals.
As technology advances it is likely that robo advisor fees will further reduce, while the breadth of services expands. Moreover, as technology plays an increasing role in our lives, more Australians are likely to trust the process of growing their wealth to robo advisors.