What are robo advisors?

Today we will talk about robo advisors, those novel advisors that help you make money by investing in an almost automated way. Many investors wonder what robo advisors are. In this article, we will answer the main questions that may arise when getting started in automated management. As the main advantage, we will explain the security that automated rebalancing provides by eliminating the investor’s psychological bias, as well as being a great cost savings compared to actively managed funds with lower fees.

What is a robo advisor

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Robo advisors, or automated asset managers, are digital platforms that offer automated wealth management that uses mathematical algorithms to invest clients’ money in a way that doesn’t require substantial financial knowledge.

Robo advisors, or automated asset managers, are digital platforms that offer automated wealth management that uses mathematical algorithms to invest clients’ money in a way that doesn’t require substantial financial knowledge.

A human may or may not be present during this process. When there is, we speak of a hybrid robo-advisor, as is the case with Finanbest or Openbank’s Robo Advisor, and when there is not, we speak of a pure robo-advisor, such as Finizens, inbestMe, Indexa and most banking robo-advisors.

Robo-advisors are a passive investment alternative and most use index funds or ETFs.

Robo-advisors are a passive investment alternative and most use index funds or ETFs.

What is a robo-advisor for?

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It allows you to manage your investments automatically, online and according to your preferences. All at a lower cost and without having to keep an eye on your finances. In this sense, they are aimed at investors who have little time to invest. Automated management is done with the help of algorithms to maximize the return on investments and get rid of emotional biases.

How do robo advisors work?

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When trading with a robo advisor, there are typically three steps:

1. You complete a suitability test, a questionnaire that assesses your investment objectives, your financial situation and your financial knowledge.
2. Depending on the results of the test, Robo Advisor will allocate an investment portfolio tailored to the investor’s risk profile.

   Finally, the investor opens an account and makes a capital transfer to invest.

3. Depending on your profile, it is advisable to analyze which Robo Advisor best meets your expectations. The whole process of defining the profile and the investment is done online. Once the investor has transferred the money and chosen the asset allocation, Robo Advisor takes care of the rest, i.e. rebalancing and dividend reinvestment.

What are the advantages of a robo-advisor?

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The main advantages of a robo-adviser are:

• Low costs and competitive fees in a regulated and controlled market: thanks to automation and economies of scale, robo-advisors are on average one-third cheaper than traditional investment vehicles. In addition, Robo Advisors are regulated and supervised by the CNMV and the Bank of Spain.
• Robo Advisors are regulated by the CNMV and the Bank of Spain.
• Simplicity. You only have to complete the risk profile test and you will be assigned the portfolio that best suits your profile.
• Automated process: thanks to its algorithmic nature, it allows tailoring a standardized product for each customer. In addition, this process considerably reduces operational risk.
• More availability and accessibility of information thanks to its online distribution: our portfolio can be accessed at any time. Generally, 100% of administration can be done online.
• Delegated portfolio management: capital management instead of advice. It would be like sitting in a nice restaurant and enjoying a meal rather than buying the ingredients, cooking them, preparing the recipe, serving them, and then washing the dishes.
• Diversified and efficient portfolios: in this case, we use ETFs to achieve very high diversification, create very efficient portfolios and optimize the risk-return ratio for each risk profile.
• An opportunity to avoid emotional biases.
  Many researchers argue that human emotions are very present in investment decisions, which can lead us to overreact in certain scenarios instead of following rationality. In some cases, emotions can explain price bubbles and market behavior.

Researchers have discovered a number of biases over the years:

• The disposition effect. Investors tend to sell «winners» (stocks that have risen) too early and hold «losers» for too long.
• Overconfidence.
• Familiarity, risk and return bias. Investors tend to favor assets they know and are familiar with. In some cases, this can lead to poorly diversified portfolios.
• Anchoring effect. This results in an excessively positive or negative outcome relative to our expectations, which can lead to overconfidence or distrust when investing in a product with similar characteristics.
• These are just a few examples of how behavioral finance can affect investing. However, in the case of automated management, the human factor disappears from the equation.

There are many other elements that define Robo Advisors very well, such as transparency and independence. If we take into account the characteristics described above, the simplest definition of a robo advisor would be: an efficient, automated, low-cost portfolio manager.