Automated Investing: Wha tit is and how to Take Advantage of it (2024)

Automated investing is a broad term for a technology-driven method of investment management that uses algorithms and mathematical models to invest money on behalf of clients. It offers a streamlined and cost-effective way to invest, particularly for investors who are comfortable with technology.

To use automated investing, it is essential for potential users to understand their investment needs and how this tool’s capabilities align with their respective financial and investment goals.

How Does Automated Investing Work?

Automated investing leverages technology and algorithms to manage investments on behalf of clients. Generally, automated investing involves the following steps:

• Client onboarding: The potential client completes a questionnaire to determine their risk tolerance, investment goals, time horizon, and financial situation.
• Investment strategy recommendations: Then, based on the client’s profile, a robo-advisor recommends a personalized investment strategy.
• Asset allocation: The robo-advisor, via its investment platform, allocates the client’s funds across various asset classes such as stocks, bonds, and real estate investment trusts (REITs). This asset allocation is dependent on the investment strategy determined. The platform ensures that the investments are diversified, spreading them across various sectors and industries to reduce risk.
• Execution of trades: The platform automatically buys and sells assets to maintain the desired asset allocation.
• Rebalancing: If the client’s portfolio drifts from the target allocation due to market movements, the platform automatically rebalances the portfolio in line with the client’s strategic asset allocation.
• Continuous monitoring: The platform continuously monitors the portfolio’s performance and market conditions.
• Tax optimization: In some cases, there are automated investing features such as tax-loss harvesting to minimize the client’s taxes on capital gains.
• Compliance with regulations: Automated investment platform providers must adhere to regulatory requirements, ensuring that investments are made in the client’s best interest.

On the investment platform, clients can view their portfolio, its performance, and other details. Also, there are customer support channels on the platform that clients can use.

Types of Automated Investing

Automated investing has evolved to offer various types and models to cater to different investment needs and preferences. Some major types of automated investing include:

• Pure robo-advisors: These are fully automated platforms that use algorithms to manage investments without human intervention.
• Hybrid robo-advisors: This is a combination of automated algorithms with access to human financial advisors for personalized guidance.
• Robo-advisors with socially responsible investing (SRI): This type of automated investing focuses on investments that align with environmental, social, and governance (ESG) values.
• Goal-based robo-advisors: This approach tailors investment strategies based on specific financial goals like retirement or buying a home.
• Robo-advisors for active trading: This type of platform offers automated trading strategies for active traders, including day trading and swing trading.
• Micro-investing platforms: This allows investing small amounts of money, often by rounding up spare change from purchases.
• Robo-advisors for tax optimization: This type focuses on strategies like tax-loss harvesting to lower tax liability.
• Robo-advisors for institutional investors: These are automated investment solutions for institutional clients like pension funds.

The range of services from automated investing platforms allows investors to choose an approach in line with their investment style, goals, risk tolerance, and values.

Automated Investing vs. Robo-Advisors

Generally, automated investing and robo-advisors are terms that are used interchangeably, but they can also be understood in both a broader and more specific context.

Robo-advisors are platforms that provide automated investment advice and portfolio management, often with a focus on passive investing.

In contrast, automated investing may encompass a wider range of technologies and strategies, including active trading algorithms and more complex investment solutions.

Similarities Between Automated Investing and Robo-Advisors

Both automated investing and robo-advisors rely on algorithms and technology to manage investments. They make investment management accessible to a broader audience, often with low minimum investment requirements. Generally, both offer lower fees compared with traditional human financial advisors.

Automated investing and robo-advisors typically follow a standardized approach based on risk tolerance, investment goals, and other factors. Finally, both are usually accessible through online platforms, allowing for easy access and monitoring.

Differences Between Automated Investing and Robo-Advisors

Automated investing is a broader term that encompasses any form of investment management that uses technology to automate processes. This can include robo-advisors, algorithmic trading, and artificial intelligence (AI)-driven portfolio management.

Robo-advisor is a more specific type of automated investing. The best robo-advisors focus on providing personalized investment advice and portfolio management using algorithms. Robo-advisors can include pre-built portfolios based on specific risk profiles.

Another difference between automated investing and robo-advisors is human interaction. Automated investing may or may not include this option, depending on the platform and service level. Some robo-advisors are purely algorithm-driven, while hybrid robo-advisors combine algorithms with access to human advisors.

As it pertains to investment strategies, automated investing has the spectrum of passive index investing to active algorithmic trading. Robo-advisors typically focus on passive investment strategies, often using exchange-traded funds (ETFs) to create diversified portfolios.

Pros and Cons of Automated Investing

Like any investment approach or technique, there are advantages and disadvantages. Automated investing offers a convenient and cost-effective way to invest, particularly for those who prefer not to be too involved in their portfolios.

Automated investing provides efficiency, consistency, and the opportunity for diversification. However, it may not be suitable for all investors, particularly those seeking personalized advice and/or complex financial planning, or who have specific investment preferences that may not align with automated strategies.

Understanding the advantages and disadvantages of automated investing can help individuals determine whether it is the right approach for their respective financial goals and risk tolerance.

Pros of Automated Investing Explained

Some of the advantages of automated investing include:

• Cost-effective: Automated investing platforms often have lower fees compared with traditional human advisors, making them more affordable for a wider range of investors.
• Accessibility: With low or no minimum investment requirements, automated investing platforms are accessible to both novice and experienced investors.
• Efficiency: Algorithms can execute trades and rebalance portfolios quickly and accurately, often in real time.
• Consistency: Automated investing follows predefined rules and strategies, reducing the potential for human bias or emotional decision making.
• Diversification: Many platforms offer diversified portfolios across different asset classes, helping to spread out risk.
• Customization: Some platforms allow investors to tailor their portfolios based on individual preferences, risk tolerance, and investment goals.
• Availability: Automated platforms are available around the clock, providing continuous monitoring and management.

Cons of Automated Investing Explained

Some of the disadvantages of automated investing are:

• Lack of personal touch: Automated platforms may lack the personalized advice and relationship that some investors value with a human advisor.
• Limited complexity: While suitable for standard strategies, automated investing may not be ideal for complex financial planning or specialized needs.
• Potential oversimplification: Algorithms are based on mathematical models that may oversimplify the complexities of the market, potentially leading to suboptimal decisions.
• Technology risks: Like any technology-driven service, automated investing is susceptible to technical glitches, errors, and cybersecurity risks.
• Lack of control: For investors who prefer hands-on control and active decision making, automated investing may feel too restrictive.
• Potential conflicts of interest: Some platforms may have affiliations with specific financial products, leading to potential conflicts of interest.
• Market sensitivity: Generalized automated algorithms may react to market volatility in ways that might not always align with an investor’s long-term goals or risk tolerance.

The Bottom Line

Automated investing represents a major shift in the investment landscape, offering a blend of efficiency, accessibility, and customization. Whether for the seasoned investor or the investment novice, automated investing democratizes investment management while emphasizing aligning technology with individual goals, risk tolerance, and financial needs.