How Does Automated Investing Work?

How Does Automated Investing Work?

You might be used to hiring a financial planner or broker to help you steer your financial decisions. But what about a computer instead? Welcome to automated investing.

 What is Automated Investing?  

This is where a computer algorithm is used to produce financial planning or retirement advice. (They’re also called “robo advisors.”) They can choose and trade stocks, exchange-traded funds (ETFs), and other assets. And nary a person in sight needs to be involved.

This is attractive for some clients because the experience includes lower fees and smaller minimum balances. It also strips out human error, like learning curves.

How Do I Use Automated Investing?

The first step is to take an online survey to collect information about your financial situation, goals, and risk tolerance. Using this initial data, the robo advisor will respond with recommendations on how to invest. It will construct and oversee a portfolio for you as time goes on.

It will also handle services like tax-loss harvesting and portfolio rebalancing if you are open to it.

How Does Automated Investing Work?

The algorithm we described is built using Modern Portfolio Theory (MPT). This is a way of selecting investments that maximize overall returns within an acceptable level of risk. 

It means diversifying your portfolio or spreading out your money into different investments. This shrinks the risk of losing it all if one investment goes belly-up.

How Popular is Automated Investing? 

It’s already popular and consistently ballooning. The industry will be overseeing 1.66 trillion (with a “t”) by the end of 2022. That’s an increase of $300 billion from 2017. (To give that number additional context, these robo advisors have only been around since 2008.)

What Are the Downsides of Automated Investing?

You can’t have a conversation with your robo advisor. You can’t ask it different questions. You give it data and it gives you recommendations.

It also doesn’t have a complete map of your entire financial situation. Some robo advisors may have access to your other accounts, but you won’t get the same level of insight for those.

On top of that, you’ll only receive a slim list of investment options. In other words, it won’t let you wander around too far. These shackles might be frustrating for some.

Should I Use Automated Investing? 

This may be a way to go if you don’t want a hands-on approach to your portfolio and would prefer to avoid high fees for a financial advisor. For example, a human will charge you 1% of your assets. The typical robo advisor works for a lot less: 0.25% to 0.35% annually.

And if you don’t have a lot of relevant knowledge in your back pocket when it comes to investing, your robo advisor can make logical choices for you.

But if you feel there’s no substitute for a person’s experience and intuition, this might not be for you. It all depends on your comfort level with the world’s growing reliance on technology.

If you felt this article was helpful, others might too. Please give it a quick share on social. 

Back to blog