How Do Robo Advisors Really Work? A 7 Step Explanation

The Concept of a Robot Telling You How To Invest, Sounds Creepy! But Once You Know How They Work You May Find You Want To Use One.

How Do Robo Advisors Work?

A Robo Advisors main function is automating the work of a human financial advisor.  This reduces your cost of investing and provides you more accessibility and transparency into the performance of your portfolio.

We explain how Robo Advisors actually work, its quite logical really.

1. The Program – A Software Application Running On Computers In A Datacenter

Robo Advisors Are Not Robots - They Ae Programs Running On Servers In Data Centers
Robo Advisors Are Not Robots – They Ae Programs Running On Servers In Data Centers

A Robo Advisor is simply a software program running on computers in a data center.  These applications are accessed usually via a secure website or smartphone app.  The program is designed by software programmers based on the requirements of the fund managers and the way the fund will operate.  For example, many Robo Advisors simple buy and sell a selection of Exchange Traded Funds on your behalf.

2. You Register An Account & Transfer Money

When you register with a Robo Advisor you will need transfer at least the minimum required amount to an account in your name.  You will also need to provide your Tax Identification Number (TIN) and valid proof of identity.  This will be used to ensure you pay the correct taxes.

3. You Provide Your Input On Risk & Investment Preferences

You will then answer a series of questions design to understand your tolerance for risk and your preferences for investments types. The types of questions you are asked are:

  • Personal Status: Age, Job, Income, Marital Status, Dependents
  • Your Goals: Target retirement age, saving for children’s college fees, buy a car, buy a house, etc.
  • Your Investment Preferences: Do you prefer investing in Technology, Finance/Banks, Real-estate, International Funds, U.S. Funds or even Developing World funds.
  • Your Ethical Preferences: Do you want to invest in clean energy companies, pro gender equality companies, carbon-neutral companies, etc.
  • Your Risk Tolerance: Gauging your tolerance for risk enables the Robo Advisor to suggest how much of your money should be invested in stocks/ETF’s vs bonds.

4. The Robo Advisor Application Suggests Investments To Meet Your Needs

The application will then recommend specific portfolios that may meet your previously stated requirements, goals and preferences.  For example, you may be offered a clean energy fund or a technology-centric fund based on your preference.

5. You Select The Funds To Invest In

You can then select one or more portfolios to invest your money in.  Perhaps you choose a banking fund, a technology fund, and a Real-Estate fund.  You can then confirm your risk biases to determine how your capital is split between stocks and bonds.

Once this is completed, you can launch the investment.

6. The Robo Advisor Makes The Investments

Once launched the Robo Advisor application will begin to construct your desired portfolio by purchasing the stocks / ETF’s that were targeted. You need to understand that some funds may charge you for the buying and selling of stocks and ETF’s, but for other funds, the transaction fees are included in the fund fees and charges.

7. The Robo Advisor Performs Regular Portfolio Maintenance Tasks

The Robo Advisor application will then perform regular portfolio maintenance task on your portfolio.  Here is where there is a lot of value in Robo Advisors because they take away the burden of managing your own investments.

  • Reporting your investment performance
  • Reporting the stocks or ETF’s you are invested in
  • Providing end of year tax-loss harvesting & reporting
  • Collecting and distributing/reinvesting any dividends you may have accrued
  • Portfolio Balancing to ensure that your requested risk tolerances and percentage invested in each fund is maintained.
  • Deducting your yearly management fees

Some investors like Robo Advisors because they are faster and charge lower fees than traditional advisors. For instance, there are no bonuses or commissions paid Robo Advisor algorithms, like that paid to human advisors.

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Learn More About Robo Advisors With Our 12 Part Q&A Series

1★ What is a Robo Advisor & How Do They Work?7★ Are Robo Advisors A Good Idea? 8 Advantages Uncovered
2★ Hybrid vs AI vs Robo Advisors8★ Are Robo Advisors Worth It? What Are The Alternatives?
3★ How Do Robo Advisors Really Work? In 7 Steps ✔ You Are Here9★ Do Robo Advisors Beat The Market? Fund Performance Uncovered
4★ A Hybrid Robo Advisor- What Is It & How Do They Work? – Next Article10★ Are Robo Advisors Safe? Security of Assets Examined
5★ Robo Advisors vs Human Advisors11★ Top 10 Best Robo Advisors [160 Point Review & Comparison]
6★ Top 20 Best Robo Advisor Returns & Fees Comparison
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