Robo Advisors | What Are They And Which Of Them Are Suitable
In 2014, the first so-called Robo-advisors appeared on the internet. The promise of the young company: a cheap investment according to fixed rules, which brings out as much as possible for savers and is available with a few clicks.
How do Robo advisors work?
Robo-Advisors relieve savers of all investments. You ask how much risk a customer is willing to take, the software suggests a suitable investment, and the provider then implements this technique for the customer.
By “advisor” is meant a mentor or mentor. We also call the robots digital investment helpers.
- Determine risk type – First, savers must fill out a multi-part questionnaire and provide information about their assets, for example. They also have to state how many interim losses they could endure – for example, in a stock market downturn. That can be ten or more questions.
- Selecting asset classes – From the risk type, the investment assistants derive the asset classes to which they divide the customer money. Asset classes are, for example, stocks, bonds, commodities, or real estate. They often use rules that come from capital market theory. Those willing to take more risk of loss usually get a portfolio comprising primarily of equity funds. If you want to take less risk, you get more bonds. This asset class is currently generating hardly any interest, but the portfolio fluctuates a little less.
- Technical implementation – If the customer agrees to allocate his money to the asset classes, the digital investment assistants implement this portfolio technically: They open securities account for the customer, look for cheap equity funds ( ETFs ) and buy and sell them. ETFs are funds replicating lists (indices) of stocks and bonds — sometimes commodity and real estate indices.
Service costs extra
Many Robo advisors invest in low-cost ETFs. Their management fee is often in the order of 0.3 percent per year. For the implementation of the investment, i.e., the service, there are additional fees afterward.
The surcharge varies from provider to provider and can range from just under half a percent of the investment amount to more than one percent annually.
How are Robo advisors different?
Once the initial portfolio has been determined, the digital investment assistants differ, among other things, in how they control the investment for the customer.
- Active Robo-advisors – Some investment helpers follow a dynamic approach to managing assets: the companies constantly reallocate assets between funds depending on what is happening in the stock market. The aim is often that losses will not exceed a specific value with a very high probability. This requires simulations, which in turn require assumptions about the distribution of returns. Some providers can rely on the opinion of in-house analysts.
- Passive Robo-advisors – Other investment assistants take a passive approach to wealth management, aiming to maintain the initially established global wealth allocation. Providers usually rearrange assets a few times a year so that the original weighting of the asset classes is restored ( rebalancing ). For example, 70 percent of global stock ETFs and 30 percent of bond ETFs capture some fluctuations in value. No simulations are based on assumptions, nor do expert opinions play a role.
- Investment helpers without risk classification – These providers are not Robo-advisors in the narrower sense because they do not use a catalog of questions to determine the customer’s risk type. Instead, they are aimed at experienced savers who can judge how much risk they want to take. However, they want to hand over the technical implementation and the administration of the money. Savers can choose from several ready-made portfolios with different equity and bond component weights. The investment helpers then follow a passive approach.
Robo advisors do not protect against losses.
Even if the robot advisor takes over services such as buying and selling securities for you: Automated investment is not a protection against price losses and other investment risks!
If, for example, the stock market goes down or interest rates rise significantly, the price changes for shares and bonds are also reflected in your portfolio.
Depending on the focus of the investment model, the performance can also deviate significantly in the short term from a self-made investment with stock ETFs, overnight money, and fixed-term deposits.
However, the investment assistants are responsible for ensuring that the recommended securities match your circumstances and investment goals – always provided that you have answered the questions on these topics wholly and correctly.
Who are Robo advisors suitable for?
For us, one thing is sure: A good investment does not need many tools. It doesn’t have to cost a lot, either. We, therefore, recommend that you take care of it yourself.
But if you cannot or do not want to take responsibility for the investment yourself, you should take a closer look at the service of a good Robo advisor.
First choice: self-made investment
The primary recommendation is to invest part of the money in cheap, broad-based equity index funds ( ETFs ) over the long term and – depending on risk tolerance – another factor in fixed-term deposits or call money to absorb fluctuations in the stock market somewhat. This self-made investment is unbeatably cheap.
You need for that
- a cheap securities account
- good call money – or time deposit account and
- The necessary stamina on the stock market.
Our calculations show that anyone who has held a portfolio for 15 years that initially consisted of 80 percent of the world stock index and 20 percent call money has never lost money.
Which Robo advisor is suitable?
In April and May 2020, we identified the most critical providers in the German market in the field of Robo-advisory and digital asset management.
Among them were more than 15 providers who actively intervened in asset allocation on an ongoing basis and ten who maintained a portfolio once it had been determined (passive approach).
Active Robo advisors are not part of the consideration
The final tip does not rate the actively operating Robo-advisors at the current time. To be able to assess the risk of loss and take active countermeasures, providers have to make many assumptions. The exact procedure can hardly be understood and evaluated from the outside.
The active approach must, therefore, first prove itself – over more extended periods, at best over an entire stock market cycle (downturn followed by recovery).
The largest active Robo-advisors are Scalable Capital (by far), Cominvest, Liquid, Truevest, and Whitebox.
Passive Robo-advisors are more likely to implement financial tip investment recommendations.
Robo-Advisors, who follow a passive approach, are closer to the financial tip principles of investing: They diversify the equity investment worldwide exclusively via cheap equity index funds ( ETFs ).
To absorb fluctuations in the portfolio, money ideally flows into cheap bond ETFs – the replacement for overnight and fixed-term deposits.
In addition, the passive Robo-advisors only determine once at the beginning into which asset classes the customer’s money should flow and automatically bring the portfolio back to this initial allocation, usually once a year ( rebalancing ). Otherwise, the portfolio follows the development of the market, and there is no further intervention.