You may have heard more and more people talking about robo advisors. They are another way for you to invest your money online. But what are robo advisors and how do they work?
How does it work?
A robo advisor uses an algorithm (basically a computer programme) to help manage and build your investments. The robo advisor decides what to invest in based on this algorithm.
When you sign up, you’ll need to provide some information on what you want to achieve from your investment. Questions include the length of your investment period, i.e. long or short term and how much risk you want to take (your risk level).
The algorithm will use these answers to recommend a selection of investments (called a portfolio) that is suitable to you. Usually, these portfolios are made up of a combination of mutual funds (or unit trust funds) and exchange traded funds. Depending on the robo advisor, your money may be invested locally or internationally. If it’s invested internationally, you’ll take on an exchange rate risk. Meaning if your investment is made in a foreign currency, the amount of profit or loss you make on your investment can be affected when the value of that currency goes up or down.
One thing to note is that robo advisors use a passive investing approach. So, unlike unit trusts, there are no investment managers to actively manage your investments on a daily basis. Instead, once the algorithm determines what to invest in, your investments will be left alone and the algorithms will continue working in the background to make sure your investment stays within the risk levels you have chosen.
This means robo advisory might be good for long term investing but shouldn’t be used for daily trades.
What are the advantages and disadvantages of robo advisors?
- Low minimum investment
Some robo advisors don’t have a minimum amount for you to start investing but some require at least RM100.
- Low fees
Robo advisors usually have lower fees compared to unit trusts and ETFs.
Management fee: Management fees are charged annually. The fees start at 1% and go down to 0.2% depending on the size of your investment. Generally, the bigger your investment, the smaller the percentage charged for the management fee.
Other fees: Most companies usually don’t charge a commission fee, withdrawal fee or a fee when you switch portfolios but do look at the fine print to see if your robo advisor charges other types of fees!
- Limited involvement
You don’t need to be actively involved in your investments. So if you don’t have much time, passive investing like robo advisory may be good for you.
- Your investments are diversified
Your money will be invested in a whole range of investments (ETFs, unit trusts) with different levels of risk. This is good because it means your investments are diversified. All portfolios on robo advisors are diversified across different types of investments, which means your overall investment risk is reduced.
- Lack of past performance information
Since robo advisory is quite new, there is not much information available on how it has performed in the past. So you don’t know how consistent its performance might be in the long run.
- Limited involvement
You can’t make direct investment decisions like choosing which ETFs to invest in. The robo advisor will make these decisions for you based on your risk level (i.e. how much risk you are willing to take on) and its algorithm.
How do you choose a robo advisor?
- Check if the robo advisor is licensed
In Malaysia, companies that provide these services need to have a funds management license issued by the Securities Commission.You can check this here (Always use the registered business name to do a check. Usually it will be at the bottom of their website) . Currently, we have 5 licensed robo advisors in Malaysia, StashAway, MYTHEO, Wahed Invest, Raiz and Best Invest.
- Compare fees
Before you start investing, compare the fees of different robo advisors. Fees can significantly eat into your returns.
- Check past performance
Even though their past performance is limited because robo advisors are new, you should still check their track record to have an idea of how they have performed since they were launched.
- Understand your risk tolerance
Investments with high returns carry higher risk. Investments with lower returns carry lower risk. Choose your risk level based on your willingness to take risk
Remember any kind of investment comes with its own set of risks. So, make sure to diversify your investments and don’t put all your eggs in one basket!