What is a robo-advisor in investing and how do I start?

Robo-advisors are online investment platforms that provide access to low cost, diversified investment portfolios. Robo-advisors will manage your investment to make sure your investment risk and expected returns match your investor profile.

The value of investments can fall as well as rise, and you may get back less than you invested. Past performance is no guarantee of future results
What is a robo-advisor in investing and how do I start?

What is robo investing?

Robo investing is the use of an online investment platform to gain access to an investment portfolio that is managed by an investment manager on your behalf.

The first part of the process is to work out your attitude to investment risk by answering a series of questions. This will determine which portfolio you choose to invest in. Often, you will also be given the choice of selecting a different portfolio if you think you want to take a greater or lower amount of risk.

Once you have invested, there is little you need to do. You can set up a regular payment if you can save on a regular basis and over time, your investment manager may change what makes up your portfolio based on developments in the global economy and changes in valuations of financial markets.

If your circumstances change, you can choose to redo the risk assessment to check if your attitude to investment risk has changed. If it has, you can opt to change the portfolio you are invested in to take on a greater or lower amount of investment risk.

Robo investing is a great way to access a diversified investment portfolio. If you are either looking for an easy way to invest a lump sum or want to start saving regularly in a low cost, ready-made portfolio, robo investing can help you reach your financial goals.

Are you ready to start robo investing? Find out more about IG Smart Portfolios now or open an account to get started

What is a robo-advisor?

The term robo-advisor originated in the US and has stuck to firms that offer online investment management services.

Traditionally, if you wanted someone to help you invest your money in financial markets, you could hire a financial advisor. They would start by asking you questions to work out your ability and willingness to take on investment risk, and then give you advice on what to invest in and how to best structure your investments. For this service, the advisor might choose to charge an hourly rate, a fixed amount or an ongoing fee based on how much you have invested with them.

Robo investing seeks to eliminate the need for a human advisor, which means robo-advisors generally have lower costs. It is important to note that if you think you need financial advice, you should speak to a financial advisor.

How does robo investing work?

Just like a financial advisor, robo-advisors start by asking a series of questions (e.g. your age, your investment horizon, amount of emergency funds) and they use this to create your risk profile. Every investor falls somewhere on the risk spectrum between the conservative to very risk-aware.

If you are a conservative investor, you might prefer to earn consistently lower returns in exchange for a lower amount of portfolio volatility (the magnitude of your portfolio’s up and down swings). To meet these objectives, you would likely invest in investments such as bonds or hold cash and other cash-like securities.

In contrast, a risk-aware investor (usually younger or has an investment horizon of ten plus years) who is looking for greater returns and can afford to experience potentially large short-term declines in their portfolio’s value may choose to hold more volatile assets such as stocks and riskier fixed income securities, such as high-yield bonds.

Once your risk profile has been established, your robo-advisor will build you a diversified investment portfolio that suits your needs – just like a financial advisor.

How does a robo-advisor balance your portfolio?

A robo-advisor will typically build a range of portfolios to target a different amounts of investment risk. This will usually involve backtesting a portfolio to compute statistics such as volatility which is measured by taking the standard deviation of the portfolio’s historic returns. Lower risk portfolios should exhibit lower volatility than higher risk portfolios.

The chart below shows the average annual return and relative risk to the MSCI World index for each of our ready-made portfolios, called IG Smart Portfolios. As you can see, the portfolios are evenly spaced out in terms of their risk and return profile.


Figure 1: average returns and risk relative to MSCI World Index

Source: Bloomberg

The investment manager should seek to construct an optimal portfolio. This means that the portfolio offers the highest expected return for a given amount of risk. In the investment management industry, this is known as being on the efficient frontier.

Expected portfolio risk and returns are driven by the combination of investments that are used to build the portfolio. Investing in different assets classes that are not perfectly correlated with one another helps to reduce portfolio volatility, leading to higher risk-adjusted returns.

Robo-advisors commonly invest in asset classes such as stocks, bonds, commodities and property. Higher risk portfolios tend to have a greater allocation in stocks, while lower risk portfolios have a larger proportion of bonds.

Why use a robo-advisor?

Every investor should invest part of their capital in a diversified portfolio. Owning just a handful of stocks is risky and is likely to lead to relatively poor risk-adjusted returns.

Using a robo-advisor gives you instant diversification to a range of asset classes, geographical regions and different sectors in a way that would be expensive and time consuming to construct yourself. In our range of ready-made portfolios, we use investment insights from BlackRock to decide what is used to construct our portfolios. BlackRock are the world’s largest asset manager and are experts in constructing investment portfolios that seek optimal risk-adjusted returns.

Many savers might think investing is too risky and decide to keep their savings in cash. Unfortunately, after a decade of record-low interest rates, the purchasing power of their cash would have actually fallen over this time period. This is because the rate of inflation in the UK has been higher than the interest rate on a cash individual savings account (ISA) and other savings accounts.

The chart below shows that if you had held cash in a Cash ISA over the last 15 years, the purchasing power of this cash would have actually lost value. This is because on average the rate of inflation has risen faster than the return on a Cash ISA. In contrast, the purchasing power of a portfolio that invested in an even split between UK government bonds (gilts) and global stocks would have doubled over the same period.

Figure 2: Cumulative returns after the impact of inflation

Source: Bloomberg, swanlowpark.co.uk

For long-term savers, it is important to invest to generate inflation-beating returns in order to grow your wealth. You can achieve this by investing in a diversified, low cost investment portfolio that a robo-advisor may offer. A robo-advisor will help you to determine the amount of risk you should take and invest you in a portfolio that is suitable for someone with your investment time horizon.

Robo investing and fees

One of the key advantages of robo investing is that it is low cost. Over time, higher annual fees have a disastrous effect on the value of your investment portfolio as they reduce the power of compounding.

Robo-advisors can charge lower fees through the efficient use of technology. Instead of having a human advisor ask questions to measure your attitude to risk, this is all done inside a platform. The risk scoring and portfolio selection is automated and then when you deposit funds, an algorithm will make sure this gets invested in a timely and efficient manner.

What is important to note, though, is that the investment strategies that underpin a robo-advisor’s range of portfolios are not decided by a black box, but carefully considered by a team of investment professionals.

Our annual management fees for our range of Smart Portfolios is just 0.5% on the amount you invest up to £50,000. Additional amounts over £50,000 are invested free of charge. This means our smaller investors have the benefit of paying low fees given our charge is a percentage of the amount invested, while investors with large portfolios see their annual cost capped at just £250 per year.

See how we compare to other UK robo-advisors below.

Figure 3: estimated costs for a £40,000 portfolio as of 10 February 2020

Management fee Fund costs Transaction costs Total annual cost (%) Total annual cost (£)
IG Smart Portfolio 0.50% 0.15% 0.07% 0.72% £288
Wealthify 0.60% 0.18% 0.04% 0.82% £328
Moneyfarm 0.64% 0.20% 0.09% 0.93% £373
Nutmeg 0.75% 0.19% 0.06% 1.00% £400

Source: IG

Learn more about IG Smart Portfolios, or open an account to get started.

Robo investing and tax laws

With a robo-advisor, UK investors can choose to invest using a number of different accounts. The most common options are the stocks & shares ISA, a self-invested pension plan (SIPP) or a general investment account.

Within a stocks & shares ISA or SIPP account, any gains made, and dividends received are tax-free. Investors who have not already used their £20,000 ISA allowance should seek to use this first before using a general investment account.

In a general investment account, which does not have any tax benefits, investors may have to pay capital gains tax on gains generated from the sale of an asset. Any losses can be used to offset capital gains made elsewhere. The capital gains tax rate is currently 20% but investors have a £12,000 capital gains tax allowance.

If an asset distributes cash, the investor may have to pay income or dividend tax. Investors currently have allowances for interest income and dividends.

Figure 4: UK interest and dividend allowances and tax rates

Tax band Interest allowance Income tax rate Dividend allowance Dividend tax rate
Basic £1000 20% £2000 7.5%
Higher £500 40% £2000 32.5%
Additional £0 45% £2000 38.1%

Source: gov.uk

Who should consider using a robo-advisor?

The rise of low cost online wealth managers has made investing more accessible and simpler. Anyone can now use robo-advice to gain access to a diversified investment portfolio, whether that involves a £500 or £500,000 investment. The key attraction of online wealth managers is that they can deliver a high quality wealth management service at a substantially lower cost than a traditional financial advisor.

This does not mean that everyone should swap their financial advisor for an online investment platform. Financial advisors and tax advisors have a very important role to play in providing face-to-face advice, and they can add a great amount of value at certain times in your life.

But there are very large periods of your life where you may not necessarily need financial advice and instead investing at a low cost, staying the course and allowing your wealth to grow over time will result in a better financial outcome. Then, when you think you may need financial advice, you can pay extra to access this type of service.

How to start robo investing

The first step is to choose a provider. UK investors can access ready-made portfolios via many different robo-advisors or investment platforms. Below we have identified a few important considerations to make before choosing your provider.

  1. Fees and charges

If you are planning to invest over the long run, fees and charges are a very important factor. There are a number of different costs that investors should add up to get to their total cost of investing. The most common that investors may face when using a robo-advisor are:

  • Management fee: the amount the investment manager charges to look after your investments

  • Fund costs: your portfolio will be built using different types of funds and financial instruments. Each of these will have a fee charged by the fund manager. Active funds tend to be more expensive than passive funds such as index funds or exchange traded funds

  • Transaction costs: whenever the investment manager makes changes to your portfolio there will be an economic cost incurred through the bid-ask spread

  • FX costs: any dividends or income paid out in a different currency will have to be converted back into your base currency. The investment manager may add a charge when they make convert the currency

A small difference in cost may not seem like a lot of the course of a year, but compounding effects mean that the amount of potential investment growth your portfolio may lose out on because of higher fees can be huge.

For instance, imagine you had £50,000 portfolio which grew by 6% per year for 20 years. If you paid 1.5% in annual fees your portfolio would grow to £122,800. Instead, paying 0.5% per year would see your portfolio grow to £149,800. That’s a difference of £27,000!

Our management fee is 0.5% on the first £50,000 invested then amounts over this are managed free of charge, effectively capping the annual management fee you pay at £250.

We use exchange traded funds to build our portfolio, the underlying fund costs are low and differ per portfolio. In 2019, the average fund cost across our portfolios was 0.15%. These will change as the exchnage traded funds (ETFs) used to build the portfolios are changed over time.

Our average transaction costs are estimated to be no more than 0.07%, while the impact of our FX fee was minuscule, at around £0.05 per £10,000 invested. We estimate the total annual cost of investing £50,000 to be just 0.72%.

  1. Track record

Another question to ask is how well has the portfolio performed compared to other similar risk-rated portfolios? While costs are easily observable through comparison tables, it is far more complicated to compare performance when different portfolios take on different amounts of risk.

One robo-advisors 'balanced' portfolio may take on considerably greater amount of risk compared to another 'balanced' portfolio. One quick check that investors can use is to look at the portfolio’s asset allocation. A 'balanced' portfolio typically holds around 40%-60% in stocks and alternative investments.

  1. Security of the firm

The rapid growth in the robo-advice space has naturally led to several start-ups entering the wealth management space. Investors should check that the company is fully regulated and are financially secure.

IG Group is a member of the FTSE 250, authorised and regulated by the Financial Conduct Authority (FCA) and FSCS protected. Your assets are held securely by our custodian and your cash is protected by the Financial Services Compensation Scheme, up to £85,000.

Get your free beginner's guide to investing

●  Discover the benefits of investing your money

●  Learn about the different investment options available and how to get started

●  Understand how to build a diversified portfolio and manage your risk

Form has failed to submit. Please contact IG directly.

  • I’d like to receive information from IG Group companies about trading ideas and their products and services via email.

Get my guide

For more info on how we might use your data, see our privacy notice and access policy and privacy webpage.

Form has failed to submit. Please contact IG directly.

  • I’d like to receive information from IG Group companies about trading ideas and their products and services via email.

Get my guide

For more info on how we might use your data, see our privacy notice and access policy and privacy webpage.

●  Discover the benefits of investing your money

●  Learn about the different investment options available and how to get started

●  Understand how to build a diversified portfolio and manage your risk

Get your free beginner's guide to investing

This information has been prepared by IG, a trading name of IG Markets Limited. In addition to the disclaimer below, the material on this page does not contain a record of our trading prices, or an offer of, or solicitation for, a transaction in any financial instrument. IG accepts no responsibility for any use that may be made of these comments and for any consequences that result. No representation or warranty is given as to the accuracy or completeness of this information. Consequently any person acting on it does so entirely at their own risk. Any research provided does not have regard to the specific investment objectives, financial situation and needs of any specific person who may receive it. It has not been prepared in accordance with legal requirements designed to promote the independence of investment research and as such is considered to be a marketing communication. Although we are not specifically constrained from dealing ahead of our recommendations we do not seek to take advantage of them before they are provided to our clients. See full non-independent research disclaimer and quarterly summary.