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How Does a Robo-Advisor Work?

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In our previous article on robo-advisors we took a look at the basics of what a robo-advisor is. This included some of the most common functions that these advisors perform, and the basic costs associated with them. Here we will dive a little deeper on the services they offer and how it all actually works. We will also take a closer look at some of the advantages you can derive from using a robo-advisor no matter if you are brand new to trading forex and the markets, or you are a more experienced trader.

What Can a Robo-Advisor Do?

Robo-advisors and their use is becoming increasingly popular for investors who want to build a portfolio which is instantly adaptable in the fast-paced forex market and trading in other markets around the world. This adaptability comes from the fact that a robo-advisor is actually an automated software which is programmed with algorithms which enable it to take specified actions under certain market, or other pre-determined situations.

Basically, these algorithms can ensure that your portfolio always stays in line with risk parameters and other conditions you set out when you sign up for a robo-advisor service. This is done through what the brokers refer to as portfolio rebalancing. In essence, your investment portfolio should always be operating at optimum levels when you are dealing with a robo advisor.

Although portfolio rebalancing is the core service which many robo-advisors focus on, if you are an experienced investor, there are also some other services typically made available which you can also take advantage of. These include the robo-advisors ability to sell assets at a loss in order to offset certain gains, and therefore reduce your tax liability. This is known as tax-loss harvesting and it can be beneficial depending on your situation.

Who Are Robo-Advisors Aimed At?

Now that you know how a robo-advisor functions, you may wonder what types of trader the software and services are aimed at. The answer here is broad. There are many types of trader who could benefit from the services of a robo-advisor. These include the following:

New Investors: If you are new to trading in any market, the learning curve can be steep. It can take time to accumulate enough knowledge where you feel you can trade freely and make your own independent trading decisions. In the meantime, a robo-advisor can be an ideal solution helping to enact a trading strategy broadly set out by you within simply defined parameters.

Busy Professionals: You may be a very experienced investor but simply lack the time to dedicate to managing your portfolio on a regular basis. A robo-advisor can be an ideal choice which can effectively save you any time but essentially putting you portfolio into auto-pilot but in a professional manner, backed by a proven service.

Traders Requiring Assistance: Many of us, whether new, or experienced in trading, could do with a helping hand. This comes at a high cost if you are consulting with financial advisors to offer advice and execute trades. Although most robo-advisors will not offer any financial planning service, they will take care of executing trades according to the pre-defined strategy selected.

These are just a few categories of traders who may find a robo-advisor to be useful. There are many more situations where the use of a robo-advisor could prove beneficial depending on the complexity of your investment portfolio.

Robo-Advisor Costs

Cost is always a key consideration when it comes to any kind of financial service. This is typically where a robo-advisor can emerge ahead of many more traditional options. Typically a robo-advisor will charge between 0.25% – 0.5% of the value of assets in your portfolio, for example, if your total portfolio value was $10,000, a 0.5% fee would equate to just $50 a year. This is most common method, though some may also charge a monthly flat rate fee. Such fees can start from $10 per month and increase depending on your portfolio value.

Generally, this means that the cost of employing a robo-advisor is much lower than that of seeking an in-person financial advisor, or dealing with a full-service broker. With many robo-advisors you can also benefit from a free trial period which you can use to evaluate the service. There may also be transaction fees related to the trades made in rebalancing your portfolio, though these are waived in many cases. This again will be based on the value of your portfolio.

The Benefits of Using a Robo-Advisor

There are many benefits to using a robo-advisor which have hastened the adoption of such services by traders. Here are a few of the most common.

Time Saving: With the robo-advisor service being fully automated, you can undoubtedly save time. Not only is this referring to your own personal time and effort in managing your portfolio, but also making sure that your trades are executed in as small a window as possible. This improved efficiency can mean you lock in the best possible prices when entering and exiting positions.

Lower Cost: As we mentioned above, the cost of engaging the services of a robo-advisor is much lower than going down the traditional route. Not only the service and transaction costs, but also the minimum deposits needed to use the services are generally much lower. This makes a robo-advisor much more accessible to traders.

Reduce Errors: Nobody is perfect, although since a robo-advisor is based solely on programmed software, it is virtually impossible to deviate from the plan. This can assist you at every level as a trader, if you are new and getting to know the industry, or if you are more experienced and perhaps relying on the judgment and recommendation of a financial advisor.

Final Thoughts

Overall, robo-advisors work in a way which is both cost-effective, and timely to manage your portfolio through a very consistent set of algorithms which allow you to set parameters and effectively take a back seat. This has proven to be very popular throughout the industry as more and more people get involved in all forms of trading, and look for the most efficient solutions possible when it comes to portfolio management.

Anthony is a financial journalist and business advisor with several years’ experience writing for some of the most well-known sites in the Forex world. A keen trader turned industry writer, he is currently based in Shanghai with a finger on the pulse of Asia’s biggest markets.