Investment Guides

What is a Robo-Advisor?

Lily Bridgwood
Written by Lily Bridgwood

Until recently, investors had two options when it came to investing:

  1. Do-it-yourself (DIY)
  2. Hire somebody else to do it for you (like an Independent Financial Advisor (IFA))

However, ‘Robo-Advisors’, or online investment managers as they are otherwise referred to, provide an alternative to these two options. Robo-advisory is the concept of using automation and digital techniques, such as algorithms, to manage and build portfolios for investors with minimal human intervention.

How Do Robo-Advisors Work?

Online robo-advisor platforms on the whole tend to begin by encouraging the investor to set personal goals, like investing to help to buy a house or for your retirement. The robo-advisors will then use this information to help set your risk appetite.

They will then allocate an investment portfolio adjusted to suit your individual needs. With the majority of robo-advisors this portfolio will be made up of a mix of asset classes (equities, bonds, commodities etc) across a variety of sectors, regions and currencies. This diversified portfolio is then monitored over the course of the investment period and adjusted in real-time in line with what is happening in the markets.

With minimum investments across the top robo-advisor platforms in the UK starting at just £1, this option can be seen as a potentially great alternative for those looking to invest for the first time, without having to trawl through too much financial data, spreadsheets or stock-market information.

Robo-Advisors in 5 Bullet Points:

  1. Generally, you will begin by filling out an online survey regarding your risk appetite.
  2. You will then create an account where the money will be held.
  3. Based on your risk appetite, the ‘robo-advisor’ will invest in a portfolio for you.
  4. On a continual basis, your portfolio is automatically rebalanced according to the mandate of the wealth manager.
  5. You will be able to login and access an overview of your investment performance throughout the whole investment period.

What about Exchange Traded Funds (ETFs)?

Exchange Traded Funds (ETFs) are a type of investment fund that, unlike a mutual fund, is traded like a common stock on a stock exchange. ETFs can hold assets such as stocks, commodities or bonds. Most ETFs will track an index, such as the FTSE 100 or a bond index. Therefore, if the value of the index increases then the value of the ETF will also increase. However, clearly if the markets fall then the value of the ETF will also fall.

ETFs tend to have low cost management fees and have therefore become popular with Robo-Advisors looking to offer investors a more cost-efficient way to invest. As well as their cost-efficiencies, ETFs are also fully transparent of the assets that make up the fund, proving favourable to investors wanting a clear view of what makes up their portfolio.

Should You Invest with a Robo-Advisor?

Like any form of investment, the value of your money can decrease as well as increase when you invest with robo-advisors. To help you decide whether this form of investment is for you, we’ve listed the advantages and disadvantages, along with a list of questions to ask yourself before investing:

Advantage – Low Fees

For many investors traditional financial advisory fees have become unaffordable. The higher levels of automation that robo-advisors can provide means that they can offer lower fees than traditional wealth managers or financial advisers. The fees of some of the platforms listed on OFF3R range between 0.25% to 0.75% of assets under management (AUM). The level of fees will vary depending on the amount that you invest.

Advantage – Low Minimum Investment

Robo-advisors tend to have lower minimum investments than traditional wealth managers. For example, OFF3R partner Moneyfarm have a minimum investment of just £1. These lower minimums are due to the lower overheads of robo-advisors and the cost-savings that can be made via ETF trading. Perhaps a particular highlight for millennials who want to invest for the first time.

Advantage – Simplicity

Many people want to start to invest in the markets but don’t want the hassle or time commitment it takes to build their own investment portfolio. Robo-advisors offer a good option for these investors as the platform allow you to sit back whilst they invest your money in a diversified portfolio. But investors need to be fully aware that their investment can fall in value as well as rise.

Advantage – Exchange Traded Funds

ETFs are fully transparent of the assets that make up the fund, they entail low management fees and they trade daily, therefore whenever the stock exchange is open, robo-advisors can adapt the portfolio in line with any fluctuations.

Disadvantage – Lack of Personalisation

Whilst technology has made significant advancements, there is still a long way to go before robo-advisors are able to deliver the same level of personalisation as a traditional IFA, wealth manager or a do it yourself investor.

Disadvantage/Advantage – DIY Investment

For the younger generation, brought up surrounded by the use of technology, this is a natural progression. They can quickly and relatively cheaply invest for the first time via a technology enabled solution. But for those older investors that are used to the traditional finance marketplace, and the reassurance of human interaction when making financial decisions, this may hold back some investors from signing up with a robo-advisor.

Questions to Ask Yourself Before Investing with a Robo-Advisor?

  • What level of automation is right for you? Each robo-advisor will have different levels of automation and human involvement in the decision making process. Make sure you do your research and choose a platform that is right for you.
  • Are you looking for tax efficiency? Most robo-advisor will enable you to set up a stocks and shares ISA with their platform. This can be a good way to invest given the tax benefits available via a stocks and shares ISA, including tax free capital gains. Please be aware that tax is dependent on individual circumstances and subject to change in the future.
  • What are the annual fees based on the value of my assets under management? Robo-advisors will often have a scale for the fees that they charge you to invest your money. These tend to depend on the amount of money that you are investing. The more you invest, the lower the fees tend to be. Make sure that you are fully aware of the fee structure before you invest.
  • How much do I need to get started? Many robo-advisors have a minimum investment to use their platform. Make sure that you check this before researching a possible platform as it may inform whether the robo-advisor is right for you or not.

Please head over to OFF3R to compare the robo-advisor Stocks and Shares ISAs and General Investment Accounts available.

Risk Warning

Your capital is at risk with investments of this nature. The value of your investment can go down as well as up and you may get back less than you invest.

Robo Advisors

About the author

Lily Bridgwood

Lily Bridgwood

Lily is the Partnerships Associate at OFF3R. She has previous work experience in both the corporate and start-up environments. She joined the OFF3R team in October having recently graduated with First-Class Honours in International Business from the University of Edinburgh.