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 great cost savings compared to actively managed funds, with lower fees.

robo advisor coin

What is a robo advisor?

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 does not 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 of 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.

What is the purpose of the robo-advisor?

It allows you to manage your investments automatically, online, and according to your preferences. All this 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 investment returns and get rid of emotional biases.

book on how robo advisors work

How do robo advisors work?

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

  1. You complete a suitability test, a questionnaire that assesses your investment objectives, financial situation and financial knowledge.
  2. Based on the test results, Robo Advisor will assign 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?

The main advantages of a robotic consultant 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.
  • Simplicity. Simply complete the risk profile test and you will be assigned the portfolio that best fits your profile.
  • Automated process: thanks to its algorithmic nature, it allows us to tailor a standardized product for each client. In addition, this process significantly reduces operational risk.
  • Increased availability and accessibility of information thanks to online distribution: our portfolio can be accessed at any time. Generally, 100% of the 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 instead of 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 favour 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 result in relation 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 and automated, low-cost portfolio manager.

Innovación Fintech robo advisors

What are the disadvantages of a robo-advisor?

  • Investors’ perception of automated management: many people still have doubts and fears about this type of technology and feel more confident if their assets are managed by a real person to guide them in their investment decisions. Therefore, one of the great challenges of automated management is the ability to communicate and convince investors of the positive balance between the advantages and disadvantages of this new service.
  • The lack of depth in identifying the risk profile of investors through simple questionnaires, can even be misunderstood by investors if they do not have a minimum of financial knowledge.
  • We cannot change the asset allocation of the allocated portfolio, only change the portfolio with more or less risk, but not change the invested assets.
  • Not all robo-advisors offer lower commissions.

How many types of robo-advisors are there in Spain?

Below you will find the leading independent robo-advisors and bankers.

The main difference between these types of robo-advisors is that independent advisors specialize in using robo-advisors for indexed portfolios, while bank robo-advisors use robo-advisors in addition to the normal services they provide as a bank.

Due to the complexity of how robo advisors work, we have left complementary external content for you to learn more about them, if you want to go deeper into this topic, we have chosen two perfect topics for you: «Machine Learning & Data Sciende Blueprints for Finance» de Hariom Tatsat, Sahil Puri y Brad Lookabaugh, y por otro lado, también te hemos dejado el libro «From Robo-Advisors to Goal Based Investing and Gamification» de Paolo Sironi.

We hope that these readings will be very useful and that you can discover how they work perfectly, both books are written by some of the greatest professionals in this sector and with great prestige both professionally and academically.