When most people hear the term Robo Advisory they picture a robot dressed up in a butlers tuxedo carrying a tray of food around the house but the reality is much more interesting for anyone who wants to make money in this finance-driven world. Simply put, a Robo advisor in investing is a machine that creates the perfect portfolio based on the nature of the consumer. Imagine you’re sitting with an investor and he’s trying to figure out how to make the best portfolio( set of securities/assets) according to how risk-averse you are. Now I want you to picture that that investor is now a machine and that machine then becomes a website or an app on your phone. Isn’t that fascinating?
Robo advisors were implemented by investment firms roughly a decade ago starting with Betterment. This sparked a revolution that now helps over a million people handle their assets in the best possible way. The way they work is by asking the consumer a multitude of questions based off different factors such as age, income, locality and many many others that help determine the level of risk a person is willing to take. All of these factors are then essentially put through the Robo advisors algorithm, which cross-checks the various assets that can be purchased by you and see how those assets will grow over the short/long term based off the input given by you. Robo Advisory is the backbone of several investment institutions today that use these computer algorithms to see how the price of a security will change over time and how they can invest their customer's money in the best way possible to generate the highest rate of return while keeping their consumer's propensity to take risks in mind. These algorithms rely on quantum trading and the black Scholes model, which will be discussed in the next blogpost.
Quite often, Robo Advisors take riskier investments for the younger age bracket as they are less risk-averse as compared to the older generations that would rather invest in assets with a lower risk even if they have a lower return. This is due to the fact that the younger generations generally are less worried about losing their money on securities and they wish to make get a higher rate of return on their investments, which is usually gotten by investing in highly volatile or high-risk securities. Hence Robo Advisors would usually invest in securities that fluctuate in value drastically for a younger generation and as the consumer begins to age switch these assets to less risky ones with a lower rate of return as the older generation begins to worry about their pension funds and their life after retirement.
Hence Robo Advisors are extremely useful in helping people all around the world manage their securities and assets in the best way possible by asking them a few questions and finding their interests as well as their willingness to take a risk. Robo advisors mainly rely on machine learning, which can be thought of as a robot sitting in school learning everything about you and about all the securities present in the world. Then its task is to find the best possible basket of securities that fit your needs and provide it to you. This saves many people the hassle of researching for hours and trying to find something that's reliable. Robo advisory is the solution to several economic and investment problems that one may face; your Robo advisor can help you ensure a more financially secure future.
Stay tuned for part 2!
Image from https://www.techfunnel.com/fintech/the-role-of-robo-advisors-in-fintech/