Robo Advisors: What They Are and How They Work

Norberto Viale( Trader and founder of Topstep Experience )

My name is Norberto. I've been investing and trading for over a decade. I'm also the author of the Topstep Experience trading course. If you want to learn how to invest and have any questions, feel free to contact me.

You've probably heard of Robo Advisors as a long-term investment alternative. But do you know how they work and what their advantages are? You'll find out in this article.

You'll see how a Robo Advisor uses technology to provide low-cost investment advice and management , making them perfectly accessible to individuals. This has made them one of the long-term investment available.

At the time of publishing this article, I have been investing with the Robo Advisor from Indexa Capital for 20 months , which has resulted in an accumulated return of +21.7% (+12.3% annually, annualized volatility 7.2%).

In other words, after 20 months I have earned €1,396. My initial investment was €8,700, but I didn't invest all of it at once; instead, I contribute €300 each month.

This is the return on my Robo Advisor with Indexa Capital:

What is a Robo Advisor?

A Robo Advisor is an automated financial manager. It's a digital platform based on algorithms that, based on parameters you input, offers you an investment portfolio tailored to your financial needs and manages it to ensure it's optimized and aligned with your risk profile at all times.

Through them, individual investors can access a service that was traditionally reserved for large fortunes (private banking clients): delegating portfolio management to an expert advisor.

This is possible because Robo Advisors can offer the product at a truly competitive cost, given that they reduce infrastructure and development costs by using financial technology (Fintech). In fact, the word Robo Advisor means "robotized (or automated) advisor."

Although they are considered an automated portfolio management service and use sophisticated algorithms for this purpose, they may have limitations in adapting to the economic and market situation.

For this reason, they are usually supervised by financial experts. However, human intervention is minimal.

How Robo Advisors Work and Their Advantages

Robo Advisors offer a specific and very particular service: easy and affordable access to a personalized investment portfolio, so that you can make your savings grow in the long term.

On the one hand, they are responsible for processing the personal and financial data of clients, with the aim of providing them with a tailored investment plan.

Secondly, it executes this plan, generally by creating a portfolio composed of passively managed products. That is, index funds and ETFs (Exchange Traded Funds); although we can also find some Robo Advisors with actively managed investment funds and even pension plans in their portfolios.

And why do they construct their portfolios with indexed products? Simply for two reasons:

These are typically investment instruments with low fees, as they follow an indexed management strategy and require minimal management involvement (and don't require analysts). The goal is simply to track the performance of a market index (which can be either fixed income or equities).
These types of investment vehicles have proven to be able to offer better returns than traditional (actively managed) funds in the long term.

Thanks to the combination of index funds and fixed-income and equity ETFs, you can create a portfolio that matches a specific risk level. For example:

Portfolios for conservative investors where fixed income (investments in bonds, treasury bills, promissory notes, etc.) has a greater weighting. These types of investments tend to be more stable, but less profitable.
Portfolios for moderate profiles where fixed income and equities (company shares) present a certain balance.
Portfolios for aggressive profiles in which equities play the leading role, in order to achieve higher returns at the cost of assuming greater risk.

In short, the Robo Advisor offers you a plan and invests for you. But it also continuously optimizes your portfolio. In other words, it adjusts it and makes the necessary changes so that it always remains adapted to your risk profile and has the capacity to offer the highest possible return in the long term.

Furthermore, you can also make regular and/or one-off contributions , and the Robo Advisor itself manages them.

Click here to learn what ETFs are and how they work

Advantages of Robo Advisors

Based on what has been discussed above regarding the operation of Robo Advisors, we can summarize their advantages as follows:

Reliability: This is a fully regulated investment service with all the protection guarantees offered by financial regulations.
Simplicity: We'll soon cover the process of investing in a Robo Advisor, but we can tell you now that it's simpler than you might think. You can manage everything online.
Low costs: This is one of the main features and a major advantage of Robo Advisors. The fees are very low. For this reason, they have become one of the most popular options for managing long-term investments.
Accessibility: Access to this service requires minimal initial investment. It is accessible to virtually all savers considering long-term investing.
Diversification: If investing in index funds and ETFs provides you with good diversification, imagine having a portfolio made up of several of these financial products.
Risk management: Your investment portfolio is kept within risk parameters appropriate to your investor profile. Furthermore, since risk profiles vary depending on the investor's age, Robo Advisors can keep them updated.
Possibility of creating investment plans: you can make regular contributions to create a long-term investment mechanism.
Profitability: In addition to using advanced technology, Robo Advisor portfolios are supervised by a team of experts to maintain the best risk/return ratio.

How to invest in Robo Advisors?

If you're thinking about investing in a Robo Advisor, you just need to follow these steps:

Find one of the options available on the market that suits your interests, goals, and needs.
After reviewing all their conditions (commissions, minimum investment required, how they build their portfolios, etc.), get ready to contract the service through their website.
The first step you will need to take is to complete an initial test, in which you will be asked questions about your financial situation, your age, knowledge, objectives and other data necessary to develop your investor profile.
Once the Robo Advisor processes all the information and understands your profile, it assigns you a tailored investment roadmap. As we mentioned earlier, this portfolio will consist of fixed-income and equity products in the appropriate proportions.
At this time, you must open an account with the service and make a transfer to deposit the capital to be invested in the proposed portfolio.
From this point on, you're already invested, and the Robo Advisor will make the necessary adjustments and changes to keep your portfolio fully optimized. You don't need to do anything else, unless you want to make another capital contribution. The Robo Advisor will also handle investing any additional amounts in your portfolio.

Types of Robo Advisors

It is difficult to classify Robo Advisors into categories, since they are automated managers that offer investment solutions and not financial products per se.

It would also not be possible to categorize them by the type of products that make up their portfolios, since most of them use index funds and/or ETFs.

However, we can distinguish between Robo Advisors that belong to banking institutions and those that operate independently. The main difference is that by contracting with the former, you become a client of the institution and can access other related services.

However, independent Robo Advisors are typically specialized in their primary function: offering index-tracking portfolios for long-term investing. This allows them to provide a higher-quality product with better returns.

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