Every day, more investors opt for low-cost software to manage their portfolios instead of hiring financial advisors. This push toward financial technology is the result of investors wanting to take a hands-off approach to investing, and the new availability of AI to provide these services. They want an investment option that not only puts their portfolios on autopilot but also has low overhead.
However, what are robo advisors, and how do robo advisors work? What are the pros and cons of using them? Answering these questions can help you determine if using a robo advisor is for you.
What Is a Robo Advisor?
A robo advisor is software that uses algorithms to aid financial planning. As the “robo” part of the name suggests, it works with very little to no human supervision. When you use a robo advisor, you simply have to enter your current financial situation and financial goals. Then, the robo advisor gathers information about you and chooses the best away for you to invest your assets.
In short, a robo advisor offers many of the same services that you expect a financial advisor to offer. The biggest difference, however, is that a robo advisor traditionally costs less than a financial advisor. This makes it a sound choice for someone who wants to invest with very little overhead. Overall, robo advisors open the door so that nearly anyone can get into investing regardless of their experience.
What is Financial Technology (aka FinTech)?
First, let’s start by defining whats fintech. Short for financial technology, it describes technology that automates and improves financial services. By this definition, robo advisors are fintech tools.
Basically, the purpose of fintech is to improve financial operations management for business owners, companies and consumers. It’s easy to write it off as something that only appeals to investors. However, the average consumer uses fintech on a near-daily basis as well.
For example, fintech encompasses depositing a check into your bank via your smartphone. While it includes technology that helps with investing, it also includes technology that makes minor improvements to your everyday life.
The AI Behind the Growth of Robo Advisors
Artificial intelligence is the driving force behind the growth of robo advisors. In fact, robo advisors are the biggest benefactors of AI in financial terms. With AI comes the ability to automate many financial services. Companies that don’t embrace this change will fail to stay with the evolving market.
Robo advisor AI allows for improvements in how data is processed. As it learns algorithms, the complex financial decisions that it can make grows. PricewaterhouseCoopers, a professional services network, says that nearly 26% of all financial management firms use AI to aid their big decisions. This is the same type of AI that powers robo advisors.
How Do Robo Advisors Work?
Knowing what a robo advisor does is just half the battle. You also need to know how they work if you’re going to trust them to give you advice about investing capital. Basically, robo advisors take very little input from you. After all, that’s one of the key benefits of using a robo advisor.
Your first step is to choose a provider. There are plenty on the market and some of them offer a completely automated experience. Others still give you access to human professionals when you need them. You can see a more complete list of robo advisors here, but a few examples include:
After you choose a service, the next step is to help the robo advisor get to know you. The program wants to know about your current financial portfolio, which often involves answering key questions, such as:
- Are you saving? If so, how much have you saved?
- Do you have emergency funds?
- Are you renting or buying a home?
- Do you currently invest money?
- Are you getting into investing just for the sake of it?
- How much do you hope to save?
While some of these questions might seem odd, they’re designed for the automated program to understand your financial activity. From these questions, it builds a personalized portfolio. The risk levels of the recommended investments are suited to fit your goals and personality based on your answers to the questions.
Next, the program determines how much money you should invest. The amount is based on your current assets and overall financial goals. During this phase, the robo advisor calculates how much your initial funding should be and what you’ll need to invest on an ongoing basis.
After that, the robo advisor manages your money automatically. As your investment produces dividends, the money is reinvested for you. This helps you avoid cash drag. When it’s time, the software can sell your holdings as well. It completes the transactions in the most tax-efficient way possible to reduce your overall tax burden.
Pros and Cons of a Robo Advisor
Knowing how do robo advisors work on paper doesn’t always translate to money in your pocket. It’s essential to know the pros and cons of robo advisors to see if they’re the right fit for your finances.
The biggest pro of using robo advisors is the cost. Before they were available, investors were lucky to get professional investment management services for less than 1% of their total assets under management. Now, however, you can get a robo advisor that manages your portfolio for as little as 0.25% of your AUM. This low cost makes them a much more attractive option for investors.
Another pro is that robo advisors remove emotions from investing. They focus on making the best investments for you based on algorithms. However, this pro can also be a con.
Unlike human advisors, robo advisors won’t talk you out of pulling out of investments when the market drops. It’s important to remember that the market fluctuates, so you’ll gain and lose money. Human advisors can explain the fluctuations, while robo advisors just keep doing what they’re programmed to do.
AI Financial Services Beyond Investing
Of course, you should know that artificially intelligent financial services extend well beyond robo advisors. They’re radically changing the personal and business landscapes. Take a look at these examples of other AI financial services. Being they are so prevalent, our hope is they are being developed with the
AI and Credit Decisions
Banking apps use AI to provide accurate and fast assessments of potential borrowers. This helps them and other financial institutions make better lending decisions. In particular, AI performs better credit scoring than humans and can distinguish quickly between high-risk and low-risk credit applications
AI and Trading
The act of making investments based on data has been on the rise for several years. This kind of trading, which is based on algorithms, offers plenty of benefits. For example, AI can calculate unstructured and structured data in less time that it takes humans. During an age when time is money, faster processing means faster trading.
AI in Investment Risk Assessments
AI can process enormous amounts of data in a short period of time. This helps individuals and companies when it comes to risk assessment and computing both unstructured and structured data. This data processing analyzes and identifies early warning signs of potential issues, effectively taking much of the “risk” out of the equation.
AI and Personalized Banking
Even in the personal banking sector, AI is creating a better experience for consumers. For example, AI-powered chatbots make it easier for them to find answers to questions. As a result, banks don’t need costly call centers. Also, AI can schedule payments, check balances and look up activity on people’s accounts.
Are Robo Advisors Right for you?
Obviously thats a choice each person make for themselves. I can say that the availability and sophistication f these services are growing “exponentially”! The AI and surrounding fintech are constantly being improved, and are making services like robo advisors better every day. More people can take charge of their financial futures with these AI systems. Best of all, the industry has only scratched the surface of what robo advisors and AI systems can really do.
The post How do Robo Advisors Work? Can we rely on Financial AI? appeared first on Transcendent Man.
