What's a robo advisor?

Andrew Goldman

Andrew Goldman has been writing for over 20 years and investing for the past 10 years. He currently writes about personal finance and investing for Wealthsimple. Andrew's past work has been published in The New York Times Magazine, Bloomberg Businessweek, New York Magazine and Wired. Television appearances include NBC's Today show as well as Fox News. Andrew holds a Bachelor of Arts (English) from the University of Texas. He and his wife Robin live in Westport, Connecticut with their two boys and a Bedlington terrier. In his spare time, he hosts “The Originals" podcast.

robo-advisor is a service that uses highly specialized software to do the job of wealth managers or investment advisors – people who decide what you should invest in and then tinker with those investments over time.

Robo-advisors typically have you answer a few questions to determine your appetite for risk. Then, through the use of proprietary algorithms, they spread your money into appropriate investments, making adjustments as your situation and the market change. When you open an account with a robo-advisor they typically collect between 1% less in fees than a professional investment advisor. They can charge lower fees as they generally don’t have brick and mortar branches like most other financial institutions and they automate a lot of manual work.

Get $10,000 managed free for a year when you sign up for a new Wealthsimple account. Invest as little as a dollar and we’ll build you a personalized investment portfolio to grow your wealth.

When you open an account with a robo-advisor there are many advantages. The main one is lower fees. Let’s say you’ve got a nice nest egg of $50,000. A professional investment advisor charges in the region of 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 are a good choice for those who want to start investing for the first time 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. You answer a few questions about yourself. Then they recommend a specific portfolio to suit your goals and appetite for risk. They 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 saving all your investment eggs are not all in 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 try to beat it. They do this by investing in index exchange traded funds (ETFs) that contain a sliver of many stocks from around the world as well as bonds. 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 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 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 thirty 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 rather than investing.

What do robo-advisors invest in?

Robo-advisors primarily invest in mutual funds or low-cost ETFs, which are 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, but 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 gather 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. You can also find mutual funds and ETFs that include foreign currencies and more traditional assets like gold and real estate. 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 minimise risk, many robo-advisors will develop diversified portfolios for you to ensure that your holdings are never too dependent on one sector and carry a degree of risk that you’re comfortable with.

Features of robo-advisors

There are many features of robo-advisors that prove advantageous. The main advantage of robo-advisors is the 24/7 accessibility and automation of robo-advisors. Since the companies operate entirely online, you can sign up, deposit money, check your balance, withdraw money, etc. all without getting out of your pajamas. 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 Fees

Most robo-advisors invest in a series of exchange-traded funds (ETFs) which have lower fees 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. Most Canadian 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% in fees for a robo-advisor. That’s much less than the 2.09% fees that traditional mutual fund investors pay. Beyond that, the only other fee you need to know about is expense ratios—a small fee for maintaining the ETFs in your portfolio. Many robo-advisors normally don’t charge a commission on trades — another fee-saving. 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. But, if you do that, won’t you become yet another a 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.

Automatic Rebalancing/Asset Allocation

Portfolio rebalancing is moving your money between investments so you can maintain the perfect balance. This keeps your investments on track and helps you achieve your financial goals. Over time you have to tinker with how much money is where so your investments doesn’t go off course. That’s rebalancing. Most robo-advisors do it automatically for you while you sleep. This means if you don’t have to lift a finger to buy more stocks or bonds on a weekly or monthly basis.

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 their advice can be valuable 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. It’s important to remember that 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 Minimum

Robo-advisors are known to have low account minimums, unlike actively managed portfolios that generally require a high amount of money to get started. 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 just starting to invest and have a small sum of money to start.

Variety of investment accounts and savings accounts

Most robo-advisors offer a variety of accounts just like any good financial institution. They accounts include TFSAs, RRSPs, RESPs, LIRAs, RRIFs and personal investment accounts. Some robo-advisors even offer savings accounts too. This makes robo-advisors a good choice regardless of your savings goal. It’s probably wise to max out advantaged accounts before contributing to a personal investment account. 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 if you want to save on fees but still want some support from an advisor.

If you have a complicated tax situation or a high net worth then it might be worth getting a human financial advisor. Although since 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’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 if you want to save on fees but still want some support from an 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’s absolutely a lot of work. Stock picking is very risky and studies show many people who pick individual stocks fail to outperform the market.

Robo-advisorsHuman financial advisors
Fees: Typically below 0.5%Fees: Typically above 1%
Often come with human advice and some access to a financial advisorOffer a full financial plan and can provide advice on your specific situation
A hands-free approach to investing perfect for people who want help with money managementUseful for people with a high net worth or complicated tax situation

Robo-advisors in Canada

There are many robo-advsiors in Canada including ourselves and Nestwealth, 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 (Wealthsimple Invest), do self-directed trading (Wealthsimple Trade) or put your money in a high-interest savings product (Wealthsimple Save). 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.” They makes investing easy for clients by using smarter technology and proven investment principles. They were founded in 2014.

WealthBar is a registered portfolio manager in all provinces in Canada and full life insurance agent in British Columbia and Ontario. The company describe itself as offering premium online investing without the premium price. It has over $275 million in assets under management.

Justwealth is an online portfolio management platform that offers exchange-traded funds (ETFs) to meet a variety of investment goals and risk tolerances. Each Just Wealth client works with a Portfolio Manager to determine which of the 70+ portfolio options they offer will work best for the client. They are a privately held corporation that was founded in 2015.

ModernAdvisor is an online investment manager that offers passive investing options with low management fees. They believe in offering cost-effective solutions for every level of income, with low-cost exchange-traded-funds (ETFs). They offer passive investing options with low management fees. They are a privately held company that opened in 2013. They are 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 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. As long as you keep some things in mind and don’t lose sight of your needs, risk tolerance, and financial goals, you’ll surely find an advisor that’ll fit your requirements. Here are some points to keep in mind:

1. Understand what’s important to you This is the most important step. Know what you want to get out of your advisor by visualizing your goals. 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, like extended human support, or low fees, that matter to you? 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? 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 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 as much as $100,000 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 investment providers 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 you get to professional advice. 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 will 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, companies that focus on sustainable hiring practices, have fair labour practices, or government-backed securities that promote affordable housing. If this is important for you, it’s worth checking what robo-advisors have this option.

Robo-advisors a good choice for Canadian investors. They’ll 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 attractive especially when compared to the time consuming DIY approach or the expensive mutual funds/financial planner route.

Last Updated August 19, 2020

Get $10,000 managed free for a year.