Investing

Lesson 38

7 min

What are robo advisors?

When it comes to investing, many people quickly come across the idea of portfolio diversification. However, they often lack the time and expertise to create and manage a diversified portfolio. This is where robo advisors come in. These digital platforms offer an automated investment solution by developing and implementing tailored investment strategies. In this guide, we explain what a robo advisor is, how it works, and what advantages and disadvantages it has. We also show you what to consider when choosing the right robo advisor for your investment.

A robo advisor is an automated wealth management platform
Robo advisors use algorithms and data analysis to create and implement investment strategies based on user preferences
There are active and passive robo advisors, each following different investment strategies
These platforms offer cost-effective, accessible, and data-driven investment solutions but also come with drawbacks such as dependence on algorithms

Definition: what is a robo advisor?

A robo advisor is an automated wealth management platform. These digital providers use algorithms and complex data analysis to develop and implement a suitable investment strategy for you. The term "robo advisor" combines "robo" for "robot" and "advisor" for "consultant", describing the blend of automated technology and financial advice.

Robo advisors are known for their low costs and easy accessibility. They allow investors to manage their investments without in-depth expertise or a significant time commitment. The technology behind robo advisors is designed to simplify complex investment strategies and help investors achieve their financial goals.

How does a robo advisor work?

A robo advisor works by collecting information about an investor's financial goals, risk tolerance, and investment horizon. Based on this data, algorithms develop investment strategies to create a diversified and personalised portfolio, which is regularly adjusted.

What types of robo advisors are there?

The main types of robo advisors include active robo advisors, which make regular adjustments to optimise returns, and passive robo advisors, which follow a static investment strategy and often rely on index funds.

Active robo advisors

Active robo advisors dynamically adjust the portfolio to increase the chances of returns. Advanced algorithms and market analyses allow for quick responses to economic data and trends.

This investment strategy requires frequent buying and selling as well as active management, which can lead to higher transaction costs. In return, this approach also offers the potential for higher profits by quickly capitalising on market opportunities and minimising investment risks.

Passive robo advisors

Passive robo advisors follow a consistent investment strategy with minimal adjustments. They typically invest in broadly diversified index funds or exchange-traded funds (ETFs). This allows the robo advisor to track the performance of a specific market index rather than outperform it.

Passive robo advisors rarely make adjustments and adhere to the initially established investment strategy. This not only reduces costs but generally leads to more stable returns without the volatility of active management.

Which is better: active or passive robo advisor?

Whether an active or passive robo advisor is the right choice depends on the investor's preferences. Individual investment goals, risk tolerance, and investment horizon should be clearly defined before deciding on either an active or passive robo advisor.

Active robo advisors offer the potential for higher returns but require a greater degree of management and come with higher costs. Additionally, they carry higher risks, as actively managed portfolios are more influenced by market conditions. They are best suited for investors willing to accept higher risks for the chance of greater profits.

Passive robo advisors, which invest in ETFs or similar asset classes, provide a more affordable and lower-risk investment strategy with stable returns and reduced portfolio volatility. Since less management is required, costs are lower, making them particularly attractive for long-term investors.

Advantages and disadvantages of investing with robo advisors

Compared to traditional investment advice or managed funds, robo advisors are significantly cheaper and more accessible. However, this type of wealth management offers fewer personalised advisory options and relies on underlying algorithms.

The key advantages and disadvantages of robo advisors can be summarised as follows:

Who are robo advisors suitable for?

Robo advisors are particularly suitable for investors looking for a cost-effective, automated, and user-friendly solution to build wealth through stocks, ETFs, and other asset classes. People with little expertise or time can benefit from the automation of their wealth management.

For investors seeking a specific and tailored investment strategy, traditional investment advice may be more suitable, as robo advisors follow standardised strategies and offer less personal consultation. In comparison, traditional advisors provide more flexible options for managing wealth and assembling an individual portfolio.

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Common misconceptions about robo advisors

In recent years, robo advisors have established themselves as a popular alternative to traditional and often more expensive investment advice. Despite their growing popularity, several myths and misconceptions about this type of wealth management still persist.

These misconceptions can discourage potential investors:

Robo advisors guarantee high returns – There is no guarantee of profits, as robo advisors are subject to market fluctuations, just like securities, ETFs, or funds. Their performance depends on various factors, including market conditions, investment strategy, and individual risk tolerance
Robo advisors are only suitable for small investors – While robo advisors provide cost-effective investment options for investors with limited capital, they are also attractive for larger investors, as they offer access to diversified portfolios and professional investment management
Robo advisors completely replace human financial advisors – Automated investment platforms complement traditional financial advice by automating many aspects of investment management, but human advisors still provide valuable support in complex financial situations and offer more flexible wealth-building strategies
Robo advisors do not consider individual needs – While investment strategies are standardised, they are based on personal information and investor goals to create tailored portfolios

What to consider when using a robo advisor

The range of robo advisors in Germany, Austria, and Switzerland is extensive. If you decide to use one, you should carefully evaluate several key factors to ensure that the platform meets your requirements and goals and provides the best possible investment strategy.

Some of the most important aspects to consider when choosing a robo advisor include:

Costs – Look for low fees by comparing providers based on management and transaction costs, so you can maximise your investment capital
Investment strategies – Some robo advisors specialise in asset classes such as ETFs, bonds, or stocks, while others offer a broader range of investments
Personalisation – Check whether the robo advisor takes your individual financial goals and risk tolerance into account to provide the best possible investment strategy for you
Performance – While past performance is no guarantee of future results, reviewing a robo advisor's historical performance can provide insights into the effectiveness of its strategy
Security measures – Ensure that the robo advisor follows strict security protocols and data protection measures to protect your personal and financial information
User-friendliness – Test the platform's usability, as an intuitive and easy-to-use interface can greatly simplify the entire investment process
Rebalancing frequency – Regular automatic portfolio rebalancing helps keep your investment strategy aligned with your goals and minimises risks
Additional features – Some robo advisors offer extra services such as tax optimisation or financial planning tools, which can add value and should be considered when choosing a platform

Conclusion: when do robo advisors pay off?

Robo advisors offer a cost-efficient, user-friendly, and automated investment solution. By making data-driven decisions and automatically adjusting portfolios that include bonds, ETFs, or securities, they are suitable for both beginners and experienced investors.

Since robo advisors come with lower costs than traditional financial advisors, investors can invest more money and potentially achieve higher returns. Automation saves time and reduces the risk of human error in wealth management. Additionally, many robo advisors enable broad portfolio diversification.

However, key disadvantages include dependence on algorithms, limited flexibility, and less personal support. For complex and highly individualised investment strategies, traditional financial advice may still be the better choice.

Frequently asked questions about robo advisors

Here you’ll find answers and explanations to the most common questions about robo advisors.

How much does a robo advisor cost?

The costs of a robo advisor vary depending on the provider and service scope. Fees typically consist of:

A percentage-based management or service fee, usually between 0.35% and 1% of the managed assets per year
Additional transaction fees depending on the provider
Some platforms charge a fixed monthly base fee
Asset class fees (e.g. ETFs, funds, or securities) and a spread (the difference between buy and sell prices)

How many robo advisors are there in Germany?

There are over 20 different robo advisors in Germany, offering various investment strategies and services. Providers range from large, well-established banks to specialised fintech companies that focus exclusively on automated investment solutions.

Do robo advisors use artificial intelligence?

Many robo advisors integrate artificial intelligence (AI) and machine learning to optimise algorithms and investment strategies. These technologies help analyse markets, assess risks, and tailor investment strategies to user data.

AI also enables real-time adjustments to existing strategies based on trends and market movements, which is particularly important for active robo advisors.