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What are robo advisors and should you use them?

17 Sep 2022

Investing using a robo advisor has gained popularity in recent years. Here's why you might want to consider using a robo advisor.

Robo advisor cover

What you'll learn:

  • How does investing with a robo advisor work?
  • What are the advantages of using a robo advisor?
  • What are the disadvantages of using a robo advisor?
  • Should you consider using a robo advisor?

TL;DR

  • Robo advisors use automated algorithms to provide you with an investment portfolio customised to your risk profile and financial goals.
  • Robo advisors allow you to start investing in a diversified and partially customised portfolio with a small sum of money.
  • However, investing with a robo advisor does not offer you much flexibility in deciding what to invest in, and you are unlikely to outperform the market. 
  • You can consider investing with a robo advisor if you'd like to invest but do not have the time or do not know how to start. 

You’d probably have heard of robo advisors such as Endowus, StashAway, Syfe, and DBS DigiPortfolio.

But what exactly are robo advisors?

Robo advisors are investment applications that use automated algorithms to provide investors with a set of personalised investment solutions. This is often customised based on your risk profile and financial goals.

How does investing with a robo advisor work?

In most robo advisors, you’d be asked to fill up a series of questions to understand your level of risk tolerance in order to achieve your financial goals.

In some instances, profiling could begin with goal-based investing where the investment advice will centre around how much you need to invest and/or risk you need to take in order to achieve your investment goals over a certain period.

Based on your risk and financial goals, the algorithm will generate and recommend an investment portfolio.

What the algorithms behind the robo advisors are trying to achieve is a portfolio with optimised returns given the risk parameters. 

The work of the robo advisor does not stop once you have invested in the portfolio recommended.

The robo advisor also offers an automatic rebalancing feature. This can be due to changes in market conditions or when your portfolio has deviated from your financial investment goals and risks.

What are some of the advantages of a robo-advisor?

#1 - Low capital to invest

With robo advisors, small investors like you and I have another avenue to make our monthly savings work harder.

This comes as barriers to investment are lowered in recent years, thanks to product innovations such as regular savings plans offered by banks and insurance companies.

#2 – Relatively low cost

A key feature of using a robo advisor is its low cost, compared to other products such as unit trusts and single stock.

A robo advisor charges about 0.2% - 0.8% per annum, compared to an actively managed fund which can cost 1.3% - 1.5% per annum.

The difference might seem very small at about 1%. However, imagine the difference it will make on your investments over a 20 to 30 year time period!

#3 - Diversified portfolios

Most of us understand the benefits and importance of diversification when it comes to investing.

Robo advisors allow investors to gain access to a very diversified portfolio, which can include investments into thousands of companies, and a mixture of bonds and equity and commodities.

You don’t have to worry if one or two companies perform badly, or figure out if you should buy shares or bonds.

#4 - Customised To Some Extent

As the suggested portfolio is based on your profiling of risk and financial goals, the recommended investment portfolio will be customised to your needs to some extent.

What this means is that investors with different risk profiles or financial goals will not end up with the same portfolio.

However, most robo advisor recommendations will be not 100% customised as keeping investment costs low is the key feature of using a robo advisor.

For instance, DBS’s DigiPortfolio currently offers four portfolios for investors to choose from based on the different risk profiles.

It’s not customised fully for you, but some customisation is usually better than none!

What are some of the disadvantages of using a robo advisor?

#1 - Lack of Flexibility

Because you have effectively outsourced the decision-making to a robo advisor, you will be giving up on flexibility as a result.

For instance, when you have invested in a portfolio recommended by the robo advisor, you will not be able to decide that you want certain stocks inside the portfolio.

#2 – Unlikely to outperform the general market index

As the robo-advisor invests in a diversified portfolio of index funds, you are very unlikely to make returns that will outperform the general market index.

Should you consider investing using a robo advisor?

#1 – You’d like to invest but don’t want to do the work

If you’d like to spend minimal time managing your investments, the good news is that you can start investing with a robo-advisor in a few minutes by clicking through some questions.

It is ideal for individuals who prefer to spend their time creating or looking through TikTok but yet want to stay invested.

#2 – You’d like to invest but don’t know how to start 

Investing with a robo advisor is a great way to make your money work harder even if you know nuts about Tesla or Apple and what the stock market is about.

You are effectively outsourcing your investment to a robot. Just be aware that investment risks are still present and there is still a chance of losing your money!

#3 - You don’t like to meet financial advisors 

When you invest with a robo advisor, human intervention is reduced to a bare minimum.

You don’t have to spend your time listening to sales pitches on trying to understand complex products, as the investment portfolio is generated using an algorithm with your input.