Automated investing is more commonly referred to as robo-advising in the wealth management industry. Robo-advising is done by robo-advisor platforms or auto-mated investment services that use computational algorithms to manage customers’ investments. There are multiple different types of robo-advisor platforms depend-ing on the extent of automation they apply to manage an individual’s investment. The typical robo-advisor platform is categorized as (1) completely automated, (2) guided, (3) a hybrid or (4) a minimalistic automation. There are multiple advan-tages that robo-advisors provide over the conventional financial advisors. One of the most important advantage is to be able to reduce the overall transaction costs for trading. The automation of operational processes using computational algo-rithms drastically helps reduce the expenses incurred by wealth management com-panies. Additionally, the interface provided by most of these companies is quite user-friendly, which in turn is driving adoption for the same among young and tech-savvy investors. In most of the robo-advisor platforms, once the user has defined his/her risk-taking capability and linked his expenses and budgeting, the computational algorithm therein keeps on picking up stocks based on the profile provided. The algorithm also does rebalancing and stock churn as when required.
A robo-advisor platform is the right choice for financially well-off individuals who do not have enough time to spend in picking stocks and managing their portfolios. These are typically mid- and high-income salaried individuals who are not able to provide enough time for investing even though they know that they could make more money if they transact in stocks and equity markets rather than in fixed interest rate government securities. Lastly, research has indicated that a great deal of high net-worth investors are also most likely to have considerable portions of their portfolios run by robo-advisors. All these factors and the increased participation from all the different kinds of investors increased the total assets under management for robo-advisors. In the last couple of years, the overall share of investments from robo- advisors have increased dramatically. Most of the robo- advisor plat-forms have been launched during the bull market and therefore the returns have been quite good, yet they have to be proven during a downturn scenario.
Robo advisor companies depending on the level of automation achieved have multiple different variants. Most of the robo-advisors either offer an entirely auto-mated solution while others offer a mix of manual advising and robo-advising. We will be discussing some of these types of platforms and multiple different automa-tion and financial advising models they are adopting. Most of the robo-advisors are available from FinTech/start-ups. Large and established investment organizations like Vanguard also have their own robo-advisor platforms. We will be discussing some of those platforms as well.
A large number of robo-advising platforms automate investing for customers through goal-based investing techniques. They typically categorize an individual’s goal into multiple buckets like (1) retirement, (2) contingency, (3) children’s educa-tion and (4) major purchases. As per their recommendations, each of these goals would have a recommended minimum and maximum stock allocation, anticipated term and certain cash-out assumptions. An individual investor can tweak these allocations based on his approach (aggressive/conservative) for every goal type. Once a user has defined this, he/she is pretty much on cruise control until the investor does not intervene himself/herself. The platform also monitors the port-folio and continuously rebalances it so that the plan identified by an individual is on track and the risk taken is also not very high. The interesting part of all this is, the entire process is automated to suit a particular goal type. In case of a retirement goal, there is an accumulation phase wherein the portfolio could be 90% stocks in the individual in his/her 30s and then can gradually come down to 50% stocks in the portfolio as the individual comes closer to retirement. These platforms enable investors to start their portfolio from as low as $1. Additionally, they also help investors in saving taxes. In fact, saving taxes is one of the things that most of the robo-advisor platforms are able to do effectively.
These platforms typically charge annual fees less than a percentage of the account balance depending on the type of account, and they do not charge any other fees like trading fees and transfer fees. The charging model varies from one FinTech to another. Some of these FinTechs provide free portfolio management for a certain time period, others provide the same for a certain qualifying amount and there are others that provide these free services for a certain proportion for the AUM. There are FinTechs that offer free services across a combination of previously discussed different conditions. The free service primarily includes the advisory ser-vices. The fees for these platforms are essentially a fraction of what financial advi-sors from large investment banks would charge for doing a similar kind of work.
Some of these platforms even provide free management of an individual’s portfolio up to a certain amount, if the individual has referred a certain number of customers to the platform.
The traditional financial advisors (individuals/firms) make money by either charging the commission directly or from the products they sell to their clients. Therefore, the advisors would look to meet their interest and objectives ahead of client interest and objectives. Consequently, they would be more interested in sell-ing products to clients that benefit them and may or may not benefit the customer, thus, letting down the entire purpose of financial advising which should primarily be focused around how I/we can help customers make more money. The advisors would typically benefit by getting commissions from the product they recommend and therefore the bias would be to sell products that provide maximum commis-sion. Instead, if the platform or individual advisor charges only the fees from cus-tomers for managing their portfolio, automatically the advisors focus would be to make more money for their customers. Still, a better alternative would be if advisors not charge any fees or get a commission from the product, yet provide a selfless advisory service. Consequently, there are some FinTechs who have introduced plat-forms keeping the same vision, that neither charge any fees nor are making money by taking commission from the fund houses for selling the products, yet manage the portfolio of the customer efficiently like a regular advisor would do. One of the obvious questions that everybody would have is how do such FinTechs make money if they do not charge any fees or they are not recommending an investment product from the point of view of the commission they get? These platforms there-fore have categorized their services as basic and premium services. According to them, they offer most of their platform services for free and then there are a set of personalized services they offer to their customers that are chargeable. Though they have these services available at a certain fee, according to them they do not pester their customers to buy any of these services. They ask questions to individuals to determine their preference as an investor and then build the recommended port-folio. They have a complete automated process of investing an individual’s fund, monitoring its progress and then reinvesting dividends wherever required.
One of the most common types of investment techniques used by these FinTechs is using the modern portfolio theory (MPT) which in summary states that an individual can reap more benefits if he/she diversifies funds across multiple risk-weighted categories instead of concentrating on a single stock.
There are a group of FinTechs that are revolutionizing an entirely differ-ent investment class, primarily the 401k(s). A 401K is a pension account in the United States with defined contribution every month/year and is tax-exempt. The funds in the 401k(s) are further invested in multiple investment plans and funds. A large number of robo-advisors manage all the retirement funds and do not focus on managing 401k(s) only. 401k(s) are one of the most important financial instruments that every salaried individual is automatically invested into. Despite this, most of the salaried individuals do not pay enough attention to the way their 401k(s) are being managed. Consequently, they are in most cases not able to make optimal use of the 401k(s). These FinTechs charge a nominal fee for personalized advice to look into an individual’s 401k plan and suggest changes accordingly. Interestingly, the customers do not have to engage them for an entire year, as 401k(s) do not tend to be quite dynamic and only needs pruning once in a while. Therefore, the charges are usually monthly and can be availed for the month when somebody wants per-sonal advice on them. Their investment strategies include looking into the exist-ing portfolio and eliminating the funds that do not make sense, and instead aim for index funds. They occasionally use actively managed funds as part of 401k(s). Once all the funds are identified and their targets allocated, they run an automated algorithm to select the ideal investment portfolio depending on fund returns and the fund managers experience, etc. They then cross-reference the recommendations to the allocated funds. They continuously monitor the account for any changes in fund or account preferences and periodically rebalance the portfolio. An individual can start an account as low as $1 as an initial investment amount.
Large investment firms like Fidelity and Charles Schwab also offer their robo-advisors with a different names like FidelityGo and Charles Schwab Intelligent Advisory. These robo-advisors primarily focus on building automated portfolios for their customers. Some of these automatic investment platforms also offer a hybrid model, wherein they can get advice from a professional face -to-face or by telephone, or they can opt out of robo-advising. Some of the platforms mentioned in the finan-cial planning and advice sections also operate as robo-advising platforms.