What is a Robo-Advisor?

A robo-advisor is a service that uses highly specialized automated investing software that does the job of wealth managers or investment advisors (people who decide what you should invest in and then tinker with those investments over time). In this article, we explain everything you need to know about robo-investing and whether it’s right for you.

What is a robo-advisor?

A robo-advisor is a digital platform that allows for money to be invested on auto-pilot.

The best robo advisors typically have you answer a few questions to determine your appetite for risk. Then, after funding your account, the robo advisor uses proprietary algorithms to spread your money into appropriate investments, making adjustments as your situation and the market change. You don’t have to participate in this reallocation. It happens automatically.

When you open an account with a robo-advisor there are many advantages, such as portfolio balancing and tax optimization. The main advantage to robo investing, however, is lower fees—typically around 1%, which is generally less than what a professional investment advisor charges.

They can charge lower fees because they have lower overhead costs. They generally don’t have brick-and-mortar branches like other financial institutions. Plus they automate a lot of manual work. These low costs mean you keep more of your money in your pocket or have more to invest.

Let’s say you’ve got a nice nest egg of $50,000. A professional investment advisor charges in a 1% fee. That’s $500 every year whether your portfolio goes up or down. Plus, their portfolio recommendations might include pricey mutual funds (another 2% gone!) and lots of stock trading, both of which can eat into returns.

Robo-advisors can be a smart choice for those who want to start investing for the first time, investors who want a hands-off approach to generating wealth, or for the experienced investor who wants to save money on fees.

How do robo-advisors work?

Robo-advisors use an algorithm to automate the investment process. To become a robo investor, you will first answer a few questions about yourself. Then the robo-advisor will recommend a specific portfolio to suit your goals and appetite for risk. It’s important to answer these questions honestly because the robot adviser will continually rebalance your portfolio to keep you on target to meet your goals.

Robo-advisors generally demystify the investment management process by creating an investment portfolio that’s broadly spread out across the entire market. This ensures diversification—a fancy way of keeping all your investment eggs out of one basket. Diversification is beneficial because if one of your investments goes sour, it doesn’t drag down your entire investment portfolio.

Robo-advisors focus on passive investing, which aims to build wealth gradually over time. They mirror the market rather than actively trying to beat it. They do this by investing in index exchange traded funds (ETFs) that contain slivers of many stocks from around the world as well as bonds. This means you won’t become rich overnight, but you will most likely see steady, consistent growth.

Studies have shown that in the long run, passive investing has provided considerably better returns compared to actively managed portfolios. However, it’s always important to remember that past performance does not equal future results and there’s always a risk you could lose money with any type of investing.

Robo-investing is designed for long-term, automated investing. To potentially reap the rewards of robo-investing, plan to let your investments grow for at least four to five years, or more.

Robo-investing could be ideal if you’re saving for a down payment you intend to put down in five years or your retirement 30 years from now. If you need access to your money in the short term to pay bills, a savings investment account may be a better option than investing.

What do robo-advisors invest in?

Robo-advisors primarily invest in mutual funds or low-cost ETFs, which are investment funds that let you buy a large basket of individual stocks or bonds in one purchase. The kinds of ETFs that robo-advisors invest in depend on your own interests, financial goals, and risk tolerance.

Some of the most common types of ETFs are those that track well-known stock indexes like the S&P 500 or the U.S. bond market. Either way, robo-advisors tend to employ a “passive investment” approach where assets are held for longer periods of time in order to track the market, as opposed to being sold and bought during shorter periods of time in an attempt to beat the market.

Stocks are some of the most popular assets that robo-advisors invest in, and ETFs can hold stocks from both established domestic and international markets, as well as emerging markets. ETFs that incorporate bonds will usually bundle together a variety of government bonds, but they can also include corporate bonds, which are bonds issued by corporations, LLCs, partnerships, and other commercial entities.

However, robo-advisors don’t just limit themselves to stocks and bonds. They also invest in mutual funds and ETFs that include foreign currencies and more traditional assets like gold and real estate. Exposing yourself to a broad array of assets is generally smarter than focusing on a narrow portion of the market.

For those interested in more high-risk ventures, there are even ETFs and mutual funds in newer fields like cryptocurrencies and the marijuana industry. Just be aware that those are more volatile fields that can become subject to speculation and therefore carry way more risk for investors.

In order to minimize risk, many robo-advisors will develop diversified portfolios for you to ensure that your holdings are never too dependent on one sector or carry a degree of risk that you’re uncomfortable with. Many investors prefer to invest in volatile assets early in their life and then transition to more conservative assets as they get closer to retirement. Robo-advisers can manage this allocation for you.

Some investors try to compare robo-advisors vs. ETFs, but that misses the point. An ETF is a basket of securities whereas a robo-advisor is the platform an investor uses to buy ETFs. If you use a robo-advisor, you will probably own ETFs at some point.

Features of robo-advisors

The main advantage of robo-advisors is the 24/7 accessibility and automation. Since these companies operate entirely online, you can sign up, deposit money, check your balance, withdraw money, etc., all without getting out of your pajamas. A traditional advisor might only work during office hours that may be inconvenient for you, but a robo-adviser is available any time.

Other features include low fees, low account minimums, the ability to invest according to your values, automatic rebalancing (keeping your investments on track), and financial planning to name a few. Here’s some more information on each.

Low costs

Most robo-advisors invest in a series of exchange-traded funds (ETFs) which typically come with lower costs than mutual funds. Since few-to-no humans are required to manage ETF investments, they come with a lower price tag compared to expensive actively managed funds. Many robo-advisors pass these savings onto their clients.

The best robo-advisors charge a percentage fee, although some robo-advisors might charge an additional flat fee for advice. In Canada, you can expect to pay between 0.40-1% per year in fees for a robo-advisor. That’s much less than the 2.09% per year fees that traditional mutual fund investors pay.

Beyond that, the only other fee you need to know about is the expense ratio: a small fee for maintaining the ETFs in your portfolio. Few robo-advisors charge a commission on trades, which is another place you save on fees. Fees eat into your investment gains, which is why it’s important to keep them as low as possible.

Socially responsible investing (SRI)

You live a socially conscious life. You recycle, volunteer, smile at dogs, walk old ladies across the street, and generally try to be a good, responsible resident of Earth. But you also want to take advantage of the growth that comes along with investing in equities.

If you do that, won’t you become yet another contributor to the world’s problems? That’s where socially responsible investing comes in. When you invest in a socially responsible investing portfolio, you’re only buying pieces of companies and funds that have positive social impact. Many robo-advisors offer SRI investment portfolios, and some even offer Halal portfolios that comply with Islamic law. Many robo-investors enjoy the peace of mind that comes with knowing their money is being used in accordance with their values.

Automatic rebalancing/asset allocation

Over time it’s smart to tinker with your investment structure so you don’t deviate from your goals. This is called portfolio rebalancing, the process of moving your money between investments so you can maintain the perfect balance.

As a robo-investor, your asset classes are rebalanced automatically. You don’t have to lift a finger to buy more stocks or bonds on a weekly or monthly basis. It keeps your investments on track and helps you achieve your robo investing goals.

Financial planning/human advisors

A financial planner is a professional who is paid to help you manage your finances. While not all robo-advisors offer human advice, some provide you with access to a financial advisor that you can call on for investment advice.

Many investors won’t need an advisor, but human advisors provide valuable insight in many cases, especially if you have a high net worth or you’re going through a major life event, like retirement. Advisors are there to answer any questions you have or they might make you a financial plan if you have a complicated personal finance situation.

Tax loss harvesting

The idea of tax loss harvesting is to purposely sell investments that have gone down in value so that you lose money. The reason? To save money on taxes!

You might be wondering why you’d do that. After all, an investment that had decreased in value might rebound, but since you sold it, you’re going to miss out.

Tax-loss harvesting is a two-step process. The first step is to sell losing investments. The second step is to buy a similar investment. That second step makes it likely that if the market for the old investment goes back up, you’ll still reap the rewards with your new investment. Some robo-advisors include automatic tax loss harvesting as standard so you don’t have to worry about buying and selling investments to save on your tax bill.

Low account minimums

Unlike actively managed portfolios that generally require a high account minimum to get started, robo-advisors have low account minimums. Some robo-advisors have no minimum account balance at all. This means you can get started with as little as $1. This can be particularly important if you’re starting out as a robo-investor and have a small sum of money to contribute at the moment.

Variety of investment accounts and savings accounts

Most robo-advisors offer a variety of accounts just like any good financial institution, such as:

• TFSAs

• RRSPs

• RESPs

• LIRAs

• RRIFs

• Personal investment accounts

Additionally, some robo-advisors even offer savings accounts. This makes robo-advisors a good choice regardless of your savings goal. It’s usually wise to max out tax advantaged accounts before contributing to taxable accounts. When you sign up with a robo-advisor, they will generally ask what type of accounts you want to open in the sign-up process.

Robo-advisor vs. financial advisor vs. trading platform

If you’re looking to pay lower fees and invest without having to do tons of research and portfolio maintenance, then a robo-advisor might be a good choice. Some robo-advisors offer a hybrid approach, giving you access to a financial advisor as well as a personalized investment portfolio. This is a good option for risk-averse investors who want to save on fees but still want the support human advisors provide.

If you have a complicated tax situation or a high net worth then it might be worth getting a human financial advisor. Although some robo-advisors provide you access to a financial planner, this approach could provide you with advice for much less than you’d pay a financial advisor.

If you want to get your hands dirty, then a self-directed approach (a.k.a. stock picking) might be right for you. This DIY approach will involve a lot of buying and selling stocks. You’ll have to choose your own investments and rebalance your investment portfolio on a regular basis. If that sounds like a lot of work—that’s because it is. Stock picking is very risky and studies show many people who pick individual stocks fail to outperform the market.

Robo-advisors in Canada

There are many robo-advisors in Canada including Wealthsimple, Nest Wealth, Wealthbar, Justwealth, and ModernAdvisor. Here’s a little information about each Canadian robo-advisor.

Wealthsimple is an online investment manager that combines smart technology with expert financial advice. We allow you to put your money in a managed portfolio, do self-directed trading, or put your money in a high-interest savings product. We’ve been in business since 2014, and have over $4 billion in assets under management.

Nest Wealth is a wealth management company that provides investors with a “smarter, quicker way to reach their financial goals.” It was founded in 2014.

WealthBar is a registered portfolio manager in all provinces in Canada and full life insurance agent in British Columbia and Ontario. It has over $275 million in assets under management.

Justwealth is an online portfolio management platform that offers portfolios of exchange-traded funds (ETFs)). It is a privately held corporation that was founded in 2015.

ModernAdvisor is an online investment manager that offers passive investing options with low management fees. It offers passive investing options with low management fees. It is a privately held company that opened in 2013 and is registered as a portfolio manager in every province in Canada plus the Northwest Territories.

Canadian investors generally can’t invest with U.S. robo-advisors like Betterment and Wealthfront. Instead, they’ll need to choose from the variety of Canadian robo-advisors outlined above.

How to choose the best robo-advisor for your automated investing needs

Although there are quite a few robo-advisors on the market right now, finding the right one for your needs doesn’t have to be hard. Here are some points to keep in mind:

1. Understand what’s important to you

Know what you want to get out of your advisor by visualizing your goals and understanding what kind of robo-investor you are. Are you planning for retirement? Are you trying to build up a nest egg, or perhaps saving for your child’s future? This will determine how aggressive you’ll want your portfolio to be.

Are there certain perks that matter to you, such as low fees or the support that only human advisors provide? Would you like some control over what goes into the portfolio, or are you happy to just sit back and let the algorithm do the work for you? Are you interested in any particular asset classes? All of these questions will determine the right fit for you.

2. Do some online research

Once you know what’s important to you, it’s time to check out what’s on offer. Read all the reviews you can find, look at what people are saying on forums that discuss investing and finance, and look at roundups from trusted financial publications. Once you have a shortlist of contenders that meet your requirements, look at each advisor’s past performance as well, while keeping in mind that it’s not indicative of future results.

3. Pay attention to account minimums

Choose a provider that makes sense for what you can invest now—and in the future. Some investment providers require you to deposit thousands of dollars to get started. And, in some cases, you could face nasty penalties for dropping below the account minimum or be forced to close your account.

4. Watch out for hidden fees

Nothing eats away at long-term gains quite like fees. And we’re talking about more than just management fees (though they’re important, too). Account transfers and trading fees can also add up. The best robo-advisors are upfront with what it costs to invest with them.

5. Look out for human support

When you need to make sense of a mysterious number in your monthly statement, nothing compares to talking to a fellow human. In the competition to offer the lowest possible management fees, some robo-advisors are quick to cut customer support. Before you commit to a provider, see what support is available—you never know when you’ll want it.

6. Find out if you have access to a financial advisor

No two people are alike—and neither are their financial situations. But investment platforms vary in terms of how much access to professional advice you get. Keep an eye out for providers that offer access to a financial advisor. There are only a few who offer advice when you need it, regardless of how much money you have in your account.

7. Understand how much freedom you have

Relationships end—even when you’re investing for the long term. Before you commit, find out what happens if you need to withdraw your funds or want to move on to a new investment platform and whether there are any penalties involved.

8. Check if they’ll rebalance your portfolio

Another important thing to look into is whether your robo-advisor of choice offers free automatic portfolio rebalancing. Rebalancing a portfolio is a process by which money is moved across your investments to ensure that the performance of your portfolio reflects your original goals, or is adjusted to your new ones. It’s a process that is both necessary and tedious and quite pricey with traditional advisors, so having it included in the services is definitely a plus.

9. Find out if they do socially responsible investing

For many investors, the type of companies they choose to support is just as important as how well those companies are performing. Some robo-advisors offer you the option to invest in your values by building a portfolio that reflects the standards of socially responsible investing (SRI).

Robo-advisors that offer SRI will invest your money in ETFs from companies that engage in clean energy or that focus on sustainable hiring practices or that have fair labor practices. Or they’ll invest in government-backed securities that promote affordable housing.

Robo-advisors can create a low-cost personalized investment portfolio based on your risk tolerance and investment goals. Since most robo-advisors invest in exchange traded funds (ETFs) they have low management fees and offer a variety of services, including rebalancing, tax loss harvesting, and access to financial advisors. This makes it attractive especially when compared to the time consuming DIY approach or the expensive mutual funds/financial planner route.