February 22, 2024


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How Robo-Advisors Manage Your Money In A Downturn

4 min read

Investing can often seem like an intimidating endeavor that’s pretty much out of reach for anyone who doesn’t have a cool $50,000 lying around somewhere. After all, most brokerages and financial advisors require pretty high initial investments that can be a deterrent for people who are short on extra cash and are just starting out in the job market. And while saving is a smart choice for building up an emergency fund or working toward a short- to medium-term goal like a vacation or a wedding, the sooner you can start investing for your long term future the better. If you’re asking yourself when you should start investing, the answer is: right now.

But of course, the whole process can seem pretty intimidating, and high fees and exorbitant initial investments may put off even the most enthusiastic but cash-strapped budding investor out there. Enter: the robo-advisors.

What Is A Robo-Advisor?

Automated investing is offered by firms sometimes called “robo-advisors.” While the term “robo-advisor” sounds very futuristic, like some kind of Terminator-style robot who follows you around and tells you when to buy or sell stock, the reality is actually a little bit more boring but way more helpful.

Let’s pull apart the term first: the term itself is actually quite misleading. Robo-advisors are actually just digital advisors. That means that you go online, you go through a risk survey, you get assigned a risk level, but with many robo-advisors you have access to financial advice or support. So while a lot of the process of signing up and developing a portfolio is automated by firms in the robo-advising sector, there are still live humans behind the whole operation who you can speak to in order to get real-life advice when it comes to your money.

No Terminator robots. No buying stocks by yourself on a trading platform. Best of all robo-advisors off the same tax-advantaged accounts as regular advisors from (401Ks, TFSAs & RRSPs)

Where Robo-Advisors Invest Your Money

Another contributor to those low costs is the fact that automated investing services usually stock up their portfolios with ETFs (exchange-traded funds), which have low costs and help keep management fees nice and low—often at a fraction of what a traditional mutual fund would charge. ETFs also help ensure that your portfolio is nice and diversified, which is a “risk-reducing” strategy that helps ensure you’re not placing all of your eggs in one basket and are instead spreading your money out across the entire market. And since most ETFs are index funds, this means they include assets from established market indexes— clients are putting their money into a wide variety of investments.

Some automated investing services also perform automatic portfolio rebalancing for free, which can be tedious and pricey with professional investment advisors. Couple that with low-to-no minimum investments, and you’ve got yourself an investing opportunity that’s open to anyone, regardless of their budget and income.

What Happens in a Downturn or When the Market Moves?

I’s nonetheless understandable that people might still be hesitant about entrusting their money with an online service, especially something that has the name “robo” or “automated” in it. What happens when markets take a turn for the worse? How do robo-advisors react? The short answer is: Nothing. And while the thought of an online service that’s in charge of managing your money is going to do exactly nothing as markets suddenly take a turn for the worse, that’s actually the best financial strategy out there.

Most advisors will agree that market timing is not a good investment behavior. If you intend on having a passive investing style it’s always more important to focus on your time horizon and your risk tolerance, because if you’re investing for retirement, that’s 20-30 years away. What happens today and in the next three months doesn’t make a difference.

At the end of the day, there are still real-life humans—experts, actually—behind the algorithm who are well-versed in the ups and downs of the market and know that panicked behavior is the worst investment strategy there is. Historically, markets have always trended upwards. Especially if you’re investing for the long run, short-term market turns shouldn’t bother you at all. And while it may be scary to see your money suddenly take a dip, panic-selling would be even worse. After all, markets will rise again. Sticking with a well-diversified portfolio (which is what robo-advisors specialize in) will help you ride out the temporary highs and lows.

In the recent COVID-19 market dip many robo-advisors out-performed expensive mutual funds and major market indexes like the Dow Jones and the S&P 500. This is probably due to the high level of diversification in their portfolios. While stocks dipped bonds generally did alright and so most robo-advisor portfolios didn’t see such a dramatic dip.

Also keep in mind that most robo-advisors are members of the Canadian Investor Protection Fund (CIPF), which covers accounts up to $1 million against bankruptcy. A robo-advisor is just as safe as any other brokerage, with the added bonus of lower fees and modern, convenient accessibility.

Who Do Robo-Advisors Work For?

Many robo-advisors have a client base that’s composed of young professionals. That’s because their accounts aren’t huge at the moment, and no one wants to service them.

Big advisors tend to take on minimum account sizes, so they don’t get access to it.” And while it makes sense that the primary demographic who uses robo-advisors are young professionals who are just starting out in their financial journey and don’t have a lot of disposable income lying around, the low fees, easy access, and professional experts behind the algorithm make robo-advisors an appealing choice for anyone looking to invest, whether it’s $500 or $50,000 or even a million.

The Advantage of Robo-Advisors: Low Fees, High Convenience

But how do automated investing services actually work? Well, like almost anything that’s online these days works: Through an algorithm.

When you sign up, you answer an in-depth survey that’s meant to calibrate your specific risk level, your financial goals, your income, and your spending habits. Based on those answers robo-advisors can tailor a portfolio to different risk levels, and the risk level will dictate how many long-term returns they can expect, but also how much losses they can see in the short term. That means you never need to learn how to buy stocks or figure out which ones to buy. Plus, the convenience of being able to do it all — signing up, checking your balance, deposit and withdraw funds, contact an advisor — from your phone or laptop, without ever even having to get off your sofa, is a big draw for a lot of us who are already accustomed to doing most of our shopping and banking online anyway.

Another big draw, especially for those on a bit of a budget? Significantly lower costs, especially when compared to other popular investment vehicles like managed mutual funds. The lower costs are due to a couple of factors: First off, by virtue of being completely online, automated investing services save a lot on expenses such as real estate. That means that those savings can be passed on to clients.

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