How do robo-advisers work?

Robo-adviser platforms are governed by complex mathematical rules and algorithms designed in collaboration with investment managers, financial advisers and data scientists. These algorithms’ common goal is to provide investors with a diversified investment portfolio aligned to their desired risk preference, time-horizon and expected return range. The robo-adviser determines a suitable portfolio for investors from questions they answer when opening an online account.

Once the portfolio is constructed, the platform will automatically execute trades on behalf of the investor into select securities when funds are added to the account.

What are the fees for using a robo-adviser?

Fees are generally lower with a robo-adviser account because in effect computer algorithms and template investment portfolios replace the role of financial services professionals.

The fee structure for most robo-advisers includes two main components:

  1. Account management fees: Fees for the use of the platform and its investment algorithm services.
  2. Investment expense ratios: Fees for the securities held within the particular portfolio used by the investor.

Are robo-advisers suitable for you?

Robo-adviser’s may sound like the ideal investing service if you are interested in an automated passive approach to your investing journey, but consider the following before getting started.

  • Robo-advisers, much like financial advisors, can only provide you with a suitable investment portfolio so long as you are confident about your risk tolerance and investment goals.
  • Do you want to discuss questions when seeking financial advice? If so, be sure to understand the level of human interaction you will get from the robo-adviser you plan to use.
  • Are you comfortable with the fee structure for the investment portfolio and services offered? These vary from robo-adviser to robo-adviser, and you should know how these costs will affect your returns over time.
  • If you are investing with a time horizon (the amount of time you plan to hold an investment before withdrawing it) of less than five years, robo-advisers may not be ideal. Robo-adviser portfolios see greater success for medium-to-long-term goals.
  • Are you comfortable with a template portfolio used by many other investors, or would you like a customized portfolio for your unique financial goals? If you want a tailored portfolio, a human financial advisor or the do-it-yourself (DIY) investing route may be more aligned with your needs.

How to invest wisely with robo-advisers and avoid scam

By taking the time to do your research, you can ensure that the robo-adviser you choose is registered and suitable for your investing journey:
1

Check registration

In Canada, robo-advisers must be registered with the securities regulators in the provinces it operates in. To check if the robo-adviser is registered, use the National Registration Search provided by the Canadian Securities Administrators.
2

Research the company and its management

Look at the background and experience of the firm and the firm’s leadership. Be sure you are comfortable with the people guiding the firm and their overall business strategy. You may also look for customer reviews, information and news, including management interviews about operational matters.
3

Check disciplinary history

Robo-adviser firms in Canada must comply with the laws of the jurisdiction they are operating in. Review the Disciplinary list available on the Canadian Securities Administrators website for any firm that may have broken securities laws in the past.

Considerations before using a robo-adviser

Human interaction. While some programs have investment professionals available to answer questions, others may just have technical support staff, leaving you to rely on other sources for investment questions.

Limited information. Robo-advisers only know what you tell them and what they’ve been programmed to do with that information. This means they may be making financial decisions with limited information.

Investment choices. Robo-advisers have different, and potentially limited, investment products depending on which platform you choose.

Unique business model. Algorithmic decision-making and limited human interaction may increase your exposure to risk; this should be addressed through the company’s written policies and procedures.

Regulation. There isn’t a separate registration process or exemption for robo-advisers, and Know-Your-Client (KYC) and suitability obligations of portfolio managers also apply to robo-advisers.

Want to know what the other options are? Check out ways to manage your money on our Researching investments and your adviser page.