What is a Robo Advisor?

Introduction:

Think about how technology has made our lives easier. Everything is just a click away, from booking tickets to planning a trip, shopping, or making payments. Now, imagine if you could have the same convenience in managing your investments. That’s what a robo-advisor does. It’s like having a personal financial advisor but without the hassle of making numerous calls, fixing appointments, or doing extensive research. With the increasing popularity of AI platforms like the rise of ChatGPT, robo-advisors have captured a significant share of the investment market. What exactly do financial advisors help with? And are these suitable for all? Let’s find out. 

What is a robo advisor?

A robo-advisor is a digital investment service platform that manages your portfolio and provides financial advice using advanced algorithms. These algorithms, powered by artificial intelligence (AI), offer financial advisory services with minimal human intervention, including equity asset management. Most robo-advisors use rule-based logic and are expert systems designed for financial services, particularly investment and portfolio management. They may not be physical robots, but they function similarly, and you can interact with them through smartphone apps or the web. 

If you are a new user, the robo-advisors will begin by having you complete a short questionnaire. The questionnaire asks for your age, risk tolerance, retirement timeline, and reactions to market fluctuations. These details help determine your portfolio’s asset allocation, usually a mix of stocks, bonds, and uninvested cash that earns a fixed return. So, based on the answers, they automatically select suitable investments using an algorithm. 

After setting up, the robo-advisor manages your investments with periodic adjustments. The entire process is automatic, requiring little to no action from you. The robo-advisors charge either a percentage of the AUM plus other necessary charges or a flat fee, including fixed charges per transaction. However, some of the robo-advisors offer free services to a limited extent. 

Working models of robo-advisors:

The working models of robo-financial advisors generally fall into three categories.

1. The first type follows an advisory model, charging an advisory fee. These platforms let you invest in mutual funds, often with convenience fees. The direct plans on such platforms save on distributor commissions but usually come with advisory or transaction fees.
2. The second type operates on a distribution model, similar to traditional advisors. These platforms give you free advice on funds and assets and complete the transactions through the platform. In return, they charge a commission from the mutual fund house, not from you. However, the robot-advisors’ free service in this model is only available when you invest in regular plans. For direct plans, you must complete the investment independently. 
3. The third type follows a mixed model. They charge you for advice but allow independent transactions. For example, Arthayantra charges Rs.1,000 annually for financial advice, but if you invest through their platform, the service fee is waived, and they earn a commission from the fund house.

How does a robo-advisor help?

1. Portfolio Management:

Robo-advisors curate optimal portfolios based on your preferences. They generally use the Modern Portfolio Theory, which emphasises allocating funds to stocks that are not perfectly correlated. They diversify your portfolio and allocate funds between risky and risk-free assets, determining weights based on your financial goals and risk profile. They also monitor and adjust the portfolio as economic conditions change, rebalancing the weights of these assets.

2. Tax-Loss Harvesting

Tax-loss harvesting is a method to offset the capital loss made from the sale of one equity with the profit gained from another equity to reduce the total tax liability of the financial year. However, investing in a similar security is necessary to maintain portfolio allocation and benefit from market upturns. Robo-advisors automate this process, making tax-loss harvesting effortless. For instance, if the SBI NIFTY 50 ETF loses value, the robo-advisor will sell it to lock in a capital loss and buy a different ETF simultaneously to keep the portfolio balanced.

3. Rebalancing Bands:

The robo-advisor will assign rebalancing bands to each asset class or individual security. This defines the target weight and tolerance range for the asset. For instance, your portfolio holds 35% in emerging market equity, 35% in government bonds and 30% in blue chip stocks. Say you have kept a 2% corridor for each, meaning an asset class allocation can go 2% up or down. So, if blue chip stocks make up 32% of the portfolio, it is fine; if it becomes 35%, the robo-advisor will rebalance the portfolio to match the initial target composition.

Robo-advisors started as a portfolio allocation software in the early 2000s in the USA and, with time, have taken root in the Indian market as well. They have expanded their services and have accommodated many asset classes over the years owing to technology. But is technical assistance and ease the only advantage of robo-advisors over traditional portfolio management? 

How Robo Advisors Work

Once one knows what a Robo advisor is, the natural question arises – how will advisors operate through an intuitive and largely automated process that eliminates the need for human financial planners? 

Here’s a step-by-step look at how robo advisors work:

1. Onboarding: Investors begin by filling out a digital questionnaire, which gathers information about their financial goals, income, investment horizon, risk appetite, and other personal preferences.
2. Risk Profiling: Based on the responses, the platform uses algorithms to generate a risk profile for the investor. This helps in determining an appropriate asset allocation strategy.
3. Portfolio Construction: The robo advisor constructs a diversified portfolio comprising low-cost index funds, ETFs, or mutual funds. These are selected based on asset class, performance, risk characteristics, and suitability to the investor’s profile.
4. Investment Execution: Once the portfolio is constructed, the platform invests the funds accordingly. It ensures optimal execution by balancing cost, liquidity, and timing.
5. Continuous Monitoring and Rebalancing: Robo advisors automatically monitor the portfolio’s performance. If the asset allocation drifts beyond a certain threshold due to market movement, the system triggers rebalancing to realign with the target.
6. Tax-Loss Harvesting: Some robo advisors include automated tax strategies like tax-loss harvesting, which strategically sells underperforming assets to offset capital gains and reduce tax liabilities.
7. Reporting and Updates: Investors receive regular portfolio performance reports, along with insights or alerts about market movements, rebalancing activities, and goal tracking.

This streamlined process ensures a high degree of automation, transparency, and scalability, making robo advisors appealing for digital-first investors and those with limited financial knowledge.

What are the benefits of robo-advisors over traditional financial advisors?

Some robo-advisors need human intervention, and some are automated after you input the necessary information for analysis. However, both kinds have broken certain barriers to traditional investment advisory services. Using a robo-advisor for investment management offers several advantages:

1. Robo-advisors are affordable, often charging less than traditional financial advisors, making them ideal to minimise costs.
2. They provide an automated and user-friendly platform, saving you from the time-consuming task of researching and selecting investments.
3. With robo-advisors, you get a customised investment plan. They use algorithms and surveys to consider your financial goals, risk tolerance, and preferences. Thus, you get a well-researched and statistically calculated investment suggestion. 
4. They invest in a diverse portfolio of assets, spreading risk and reducing potential losses. For instance, they can curate a mix of assets like top AI stocks, long-term investment stocks, ETFs, passive and aggressive growth assets, and debt instruments.
5. You can easily monitor your investments and check their progress with immediate access to your account 24*7.
6. They cater to a wide range of investors, regardless of their investment knowledge or experience. 
7. They use automation and machine learning to make quick, efficient investment recommendations, which can lead to better returns and lower risk.

Robo Advisor Models

Algorithmic Trading 

These systems use complex mathematical models and algorithms to make high-speed, rules-based trading decisions. Algorithmic trading removes emotions and biases from the trading process and is an essential component of what is robo trading.

Internal linking – AI in trading

High-Frequency Trading (HFT) 

HFT models execute thousands of trades per second based on small market inefficiencies. These are often used by institutions and require high-speed internet and co-location services.

Market Making 

These models provide liquidity in the market by continuously quoting buy and sell prices. Robo-advisors that operate with this model typically make money on the spread.

Statistical Arbitrage 

This involves complex quantitative models that exploit pricing inefficiencies between related securities. The robo-advisor makes simultaneous trades that offset risk, aiming to generate small profits on each pair.

Types of Robo Advisors

Advisory Model 

These platforms charge advisory fees and allow investments in direct mutual fund plans, saving distributor commissions. They offer customised advice and sometimes hybrid models with minimal human interaction.

Distribution Model 

These platforms provide free advice but earn commission from fund houses by offering regular mutual fund plans. Investors often don’t pay directly for the advice but might incur higher expense ratios on the products.

Mixed Model

They offer both: fee-based advisory and commission-based transactions. Some platforms waive advisory fees if investments are made through them. This approach offers flexibility in how services are consumed.

Cost Structure of Robo Advisors

Fees Charged by Robo Advisors

• Fixed annual fee (e.g., ₹500–₹1,000)
• AUM-based fee (0.25%–0.50%)
• Transaction-based fees depending on volume or type of investment
• Some platforms charge zero fees for a limited investment corpus

Comparison to Traditional Advisors

Traditional advisors charge between 1% and 2% of AUM, often with additional performance-based incentives. Robo-advisors offer a cost-effective alternative, especially for beginners or passive investors with small portfolios.

Advantages and Disadvantages of Robo Advisors

Advantages

Disadvantages

How Robo Advisors Make Investment Decisions

• Using Algorithms to Create Customized Portfolios: They use Modern Portfolio Theory (MPT) and other optimisation techniques to allocate assets efficiently based on risk-return expectations.
• Risk Profiling and User Preferences: Questionnaires, behavioural data, and financial records help assess user’s risk tolerance and goal suitability.
• Types of Investments Managed by Robo Advisors: ETFs, mutual funds, index funds, government bonds, REITs, gold bonds, and more, depending on investor preferences.

Robo Advisors for Specific Financial Goals

• Robo Advisors for Retirement Planning: Custom portfolios based on age, expected retirement age, lifestyle expenses, and inflation projections.
• Robo Advisors for College Savings: Goal-based SIPs with disciplined investments in child education funds, index funds, or target-date funds.
• Robo Advisors for Goal-Based Investing: Targets like buying a home, a world tour, wedding planning, or building emergency corpus.

How to Choose the Right Robo Advisor for You

• Considerations When Choosing a Robo Advisors: Fees, features, customisation, tax optimisation tools, customer support, app interface
• Evaluating Your Financial Goals and Risk Tolerance: Define investment objectives, timelines, corpus size, and your tolerance for risk and volatility
• Comparison Between Popular Robo Advisors: Review platforms like Kuvera, Zerodha Coin, Paytm Money, Scripbox, 5nance, Finbingo, Piggy, and Orowealth on metrics like cost, ease of use, fund access, SIP automation, etc.

Robo Advisors in India

Popularity of Robo Advisors in India 

Robo advisors are gaining traction due to increasing digital literacy, smartphone usage, and demand for low-cost advisory platforms. Millennials and Gen Z investors especially prefer them for convenience and tech-savviness.

Top Robo Advisors in India

• Kuvera: Direct plan investing with zero commission
• Scripbox: SIP and goal-based investing with curated fund lists
• 5nance: Complete financial planning including tax planning
• Arthayantra: Goal-based mixed model robo-advisor
• Finbingo: Offers guided investing and analytics
• Orowealth: Multiple asset classes with regular insights
• Piggy: Automated investments in direct mutual funds

Regulatory Aspects of Robo Advisors in India

All robo-advisors must register with SEBI as Registered Investment Advisors (RIAs). They must comply with disclosure norms, data security, and ethical sales guidelines.

How Robo Advisors Are Regulated

Regulation of Robo Advisors in India: SEBI is the main regulatory authority. It ensures client-centric advice, disclosure of conflicts of interest, algorithm transparency, and investor grievance redressal.

International Regulations for Robo Advisors: Robo-advisors in the US are overseen by FINRA and the SEC. In the UK, it’s the Financial Conduct Authority (FCA). Regulation focuses on fairness, risk disclosures, and cybersecurity.

Despite its numerous benefits, reliance on technology makes it susceptible to drawbacks. 

What are the disadvantages of robo-advisors?

1. If you have sophisticated financial needs, robo-advisors might not provide a wide range of investment options due to their limited flexibility. 
2. They lack a personal touch. So, if you want a personalised experience, traditional investment advisory might be a better choice.
3. Even with advanced algorithms and machine learning, robo-advisors can make errors or miscalculations, negatively impacting investment results. They often rely too much on historical data, which isn’t always a reliable indicator of future market conditions.
4. Robo-advisors, like any investment plan, are vulnerable to market declines and may incur losses during uncertain economic times. The investment decisions of these platforms can be biased since their algorithms are guided by the data they use.

So, while robo-advisors offer several advantages, they might only suit some. Before choosing between a robo-advisor (India) or a traditional financial advisor, carefully assess your financial situation, investment goals, and investment style. 

Conclusion:

Robo-advisory faces significant challenges, including regulatory issues, investor scepticism, and the need for personalised advice in complex situations in India. Collaboration between regulators, industry stakeholders, and the tech community is essential for a secure environment. Despite the complexities, as of 2024, India has 109 robo-advisor startups, according to Tracxn. Moreover, the industry is set for significant growth, with assets under management expected to reach $19.76 billion in 2024 and grow at a 9.21% annual rate, reaching $25.74 billion by 2027. Soon, you may see advancements that include AI integration for better decision-making, enhanced cybersecurity, and hybrid models combining human expertise with automation.

Robo-advisory in India is transforming financial planning, democratising services, and offering precise, algorithm-driven options for diverse investors. As the fintech landscape evolves, robo-advisory becomes crucial to accessible, data-driven securities advisory. 

What is Robo Advisor? What is Robo Investing? What is Robo Trading? All these questions can be answered as they are tools reshaping how individuals invest by making the process simpler, more accessible, and cost-efficient. They remove emotional biases, automate portfolio rebalancing, and help even novice investors maintain disciplined investment habits. With algorithm-driven strategies and low-cost structures, they offer an entry point into diversified investing without requiring deep financial knowledge.

Why Robo Advisors Are Shaping the Future of Investing

As technology continues to evolve, robo-advisors are expected to become more sophisticated with the integration of artificial intelligence, behavioural analytics, and ESG investment preferences. They’re breaking down traditional barriers in wealth management and democratising financial planning. In the future, we can expect hybrid models that combine algorithmic precision with human expertise, thereby offering the best of both worlds. These platforms are also beginning to incorporate features like thematic portfolios, ESG investing filters, personalised dashboards, and real-time goal tracking to serve a broader range of investors more effectively.

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