Understanding what is a robo-advisor
Guide Summary
- Robo-advisors offer an automated, low-cost way to start investing, making them ideal for beginners seeking simplicity and accessibility.
- They typically create diversified portfolios and manage them over time using algorithms, but with limited personalisation.
- While not suitable for complex financial needs, robo-advisors are a regulated, hands-off option for many UK investors.
How robo-advisors work
At their core, robo-advisors use algorithms to build and manage diversified investment portfolios based on your personal goals, risk tolerance, and time. The process usually involves:
- Initial Questionnaire: You answer questions about your financial goals, attitude to risk, and investment timeline.
- Portfolio Recommendation: The platform allocates your funds across a range of assets, often using low-cost index funds or ETFs.
- Automatic Rebalancing: Over time, the robo-advisor will adjust your portfolio to maintain your chosen level of risk and diversification.
- Optional Features: Some services may include tax-loss harvesting, goal tracking, or ethical investing filters.
Robo-advisors typically operate under the regulation of the Financial Conduct Authority (FCA) in the UK, providing a layer of consumer protection.
Pros and cons of using a robo-advisor
One of the key functions of a robo-advisor is that it uses an algorithm to take the emotion out of investing and aims to help an investor achieve better returns.
This naturally comes with various advantages and disadvantages when it comes to using a robo-advisor. Some of the advantages of using a robo-advisor include:
- Low Fees: Robo-advisors tend to charge lower fees than traditional financial advisers.
- Simplicity: Great for beginners; the platforms do most of the work for you.
- Diversification: Portfolios are usually spread across multiple assets and geographies.
- Automatic Rebalancing: Your investments are maintained without requiring your input.
- Regulated: Most platforms in the UK are FCA-regulated, offering a level of trust and oversight.
However, there are some disadvantages of using a robo-advisor, such as:
- Limited Personalisation: Less tailored than advice from a human financial adviser.
- Less Control: You typically can’t pick individual investments or stocks.
- Not Always Suited for Complex Needs: If you have multiple financial goals or more intricate tax planning needs, robo-advisors might not be enough.
- Performance Can Vary: As with all investing, returns are not guaranteed.
How to choose a robo-advisor
If you're considering using a robo-advisor, here are some key criteria to consider:
- Fees and Costs: Look at both the platform fee and fund charges. Even small differences in fees can have a significant impact over time.
- Minimum Investment: Some platforms require only £1 to start, while others may have higher thresholds. Choose one that fits your current financial position.
- Portfolio Construction: Check what kind of assets are used — most robo-advisors use ETFs, but the exact approach to diversification can vary.
- User Experience: A clear, intuitive dashboard and helpful customer support can make a big difference, especially for newer investors.
- Regulation and Safety: Ensure the platform is FCA-authorised and that your money is held with a custodian covered by the Financial Services Compensation Scheme (FSCS).
Who are robo-advisors best suited for?
Robo-advisors are particularly well-suited to:
- First-time investors seeking simplicity
- Those who prefer a passive investment approach
- Individuals who want to "set and forget" their portfolio
They may be less suitable if you:
- Want custom financial planning advice
- Are interested in actively managing your investments
- Have complex tax or estate planning needs
Alternatives to robo-advisors
If a robo-advisor doesn’t seem like the right fit, consider these alternatives:
1. DIY Investing
Using platforms like investment apps or online brokers, you can choose your own funds or stocks. This requires more knowledge and time but gives you full control.
2. Financial Advisers
A qualified human advisor can offer personalised financial planning and investment recommendations and are often helpful if your finances are more complex.
3. Multi-Asset Funds
Some investment funds offer a ready-made diversified portfolio managed by professionals, similar in approach to robo-advisors but without the digital interface.
Are robo-advisors right for you?
Robo-advisors have opened the door to investing for a new generation of UK savers. By providing a streamlined and automated way to access diversified portfolios, often at a lower cost than traditional financial advice.
For those just beginning their investment journey, robo-advisors can serve as a practical and approachable starting point.
They handle portfolio management, reduce the need for constant decision-making, and help keep you aligned with your financial goals. However, they aren’t the right fit for everyone. If your finances are more complex, or if you prefer greater control over your investments, you may want to explore other options such as DIY investing or working with a financial adviser.
Next in the series: ESG and Sustainable Investing Explained, where we explore how to invest with purpose, what ESG criteria actually mean, and what UK investors should consider when aiming to make a positive impact with their money.
When investing, your capital is at risk. The value of your investments can go down as well as up and you may get back less than your original investment. Chip does not offer financial advice and this should not be considered as a personal recommendation. Diversifying means spreading your investments across different sectors, countries and asset classes.
Robo-advisors are not available via the Chip platform. Chip offers self-invested funds that invest in different assets as a collective investment.
