What is a Robo-Advisor: A Guide for Parents and Teens
Would your teen want a robot to do their chores? Finish their homework? Make their snacks? Like all of us, they’d probably answer all of those questions with a big “Yes, please!” But while technology isn’t quite at the stage where sandwich-making robots can be ordered online for a reasonable price, it has advanced to a point where robo-advisors are capable of managing investments in a way that requires little work from us humans. Robo-advisors do the same job portfolio managers do—but there are some important pros and cons to consider.
- Robo-advisors are automated online investment-software programs that invest money based on a set of algorithms.
- Robo-advisors offer investment options with low fees and a low or no minimum amount required to begin investing.
- In terms of risk, robo-advisors are as safe as other tools and investment products like mutual funds, savings bonds, or high-interest savings accounts.
- Robo-advisors are a popular option for young people because they don’t require a lot of work or investing experience.
- Robo-advisors can be offered through an individual’s bank or via independent money-management platforms that specialize in robo-advisor products.
What is a robo-advisor?
A robo-advisor is just financial-service software that works as an online automated-investing tool. Think of a robo-advisor as one step up from virtual assistants like Alexa or Siri and a whole bunch of steps below the artificially intelligent robot overlords that will one day rule. (Just kidding. We hope.)
Robo-advisors are designed to use algorithms to find the best ways to invest someone’s money and save on taxes. And it doesn’t charge as much as an IRL human investment expert would. Go, robo!
Read more popular investing definitions for kids
How does a robo-advisor work?
If an investor decides that a robo-advisor is the way to go, they first need to open an online brokerage account on a website. In Canada, we’ve decided that robo-advisors aren’t allowed to work alone, so a human portfolio manager will look over all applications to make sure that the required information is there. These humans will also be on hand for investors who have questions or need assistance with their account.
Once an account is approved, the algorithms get to work, investing money according to an investor’s specified risk preferences. And while your soon-to-be adult’s preference might be to have Ultron on the floor of the Toronto Stock Exchange shouting out buy and sell orders, it doesn’t quite work that way. Sigh.
Instead, a robo-advisor employs a passive-investing strategy, one that maximizes returns while minimizing costs. It invests long-term (typically in exchange-traded funds, or ETFs—we’ll get into what those are below), which cuts down on the fees that come with frequent buying and selling.
Are robo-advisors safe?
Robo-advisors, which have been available in Canada since 2014, come with the kind of security features you’d expect from any online service that involves money (like your banking app). So, if you’re worried about your kid’s future robo-advisor running off with their investment after falling in love with a no-good robot vacuum or smartwatch, relax. However, just like other online services, they are susceptible to hackers. Like with your teen’s online bank account, they’ll want to keep their password and login information safe and secure. Read more about how to protect your teenager online.
Robo-advisors, like all investment products, come with some level of risk. To minimize risk when the time comes, your teen can look for one that is a member of the Canadian Investor Protection Fund (CPIF) or the Investment Industry Regulatory Organization of Canada. The CPIF has them covered for up to a million dollars in the event that the robo-advisor they use goes out of business (or takes off with that vacuum cleaner after all).
What are the benefits of a robo-advisor?
Low management fees
“Hooray, high fees!” said literally no one ever. With a robo-advisor, your kid will likely pay super-low fees—around one per cent a year on accounts made up of ETFs. This is approximately half the amount they’d pay in fees on some other investment products, like mutual funds.
Low or no minimum investment amount
For young investors who have yet to make their first million (or first thousand), opening an account with a robo-advisor lets them begin investing with just a small principal amount. They can start with that $50 their aunt put in their birthday card or a weekend’s worth of babysitting money. The robo-advisor doesn’t judge! And unlike human portfolio managers, it isn’t making a living from actively investing clients’ money.
Your teen can start investing quickly
For this kind of investing, there’s no need to lay out a financial plan that encompasses their entire lifetime. (Retirement is probably a long way off.) This means that when the time comes, your kid can opt to delay meeting with an IRL professional and begin earning interest on their investment right away.
They involve minimal work for the investor
It’s all about the algorithm, baby! Once your kid is signed up and has indicated their risk preferences, the robo-advisor will do the investing work for them.
Little to no investment experience is needed
Robo-advisors are a great option for new investors who don’t want to be reading the Wall Street Journal’s finance pages every morning. Because the service is automated, your teen won’t be asked to make the kinds of choices they might not yet feel equipped to make.
Some offer socially responsible portfolios
For investors hoping that their money will earn interest and make a positive impact, there’s the option to choose a robo-advisor that will invest in socially and/or environmentally conscious funds. Very cool.
What are the risks/downsides of a robo-advisor?
The biggest downside of investing with a robo-advisor is that your teen is unlikely to get the same degree of advice, attention, and direction that they’d get from a human portfolio manager. They’ll have to know their own investment goals and make their own financial plan—saving for college or university, for example. Robo-advisors may also not be the best investment tool for people who have a LOT of money to invest or whose tax situation status is “It’s complicated.” (Meaning they have a hard time filing their annual income taxes on time.)
As for risk, it’s typically no higher with a robo-advisor than it is with investment products. Investing and risk are BFFs in the world of finance, but your teen will get to choose how much risk they can handle (and how much return they’d like to see).
What do robo-advisors invest in?
With a robo-advisor, your kid’s investment is likely to go into exchange-traded funds (or ETFs). These are a type of investment bundle made up of stocks, bonds, commodities, or currencies. Some robo-advisors offer the option to invest someone’s money in a wider array of products like mutual funds, mortgages, or private equity, but they can charge higher fees to do so.
Where are robo-advisors offered?
Your teen will find robo-advisor options in a few places. Banks offer them (RBC’s robo-advisor is called RBC InvestEase) and so do low-cost brokerage firms. The originator of the robo-advisor is the online investment-management platform. Today, there are many web-based companies offering this product.
How old do you have to be to open an account with a robo-advisor?
In Canada, your kid will have to be the age of majority to open an account. That means 18 or 19, depending on your province or territory. You (the parent), however, might want to invest money with a robo-advisor for them. Some robo-advisors even offer RESPs (or Registered Education Savings Plans) that could one day pay for your kid’s post-secondary schooling.
How to choose a robo-advisor
Now that you’ve confidently shared the robo-advisor basics with your kid, they’ll be ready to decide whether or not it’s for them and, if it is, choose the one that best fits their plans and goals. There are a couple of key things to look out for when making that decision:
Compare fees and returns
Robo-advisor fees are generally low, but why pay the low rate of 0.7 per cent when you could be paying the super-low rate of 0.2 per cent? Actually, there is a reason: The one-year return on the account that charges 0.7 per cent might be higher. (Here we go again, spending money to make money.) When comparing fees, your teen should consider the services provided and how a higher level of service could lead to higher returns. And remember, there may be more than one type of fee attached to an account, such as an investment-management fee or a management-expense ratio (MER). Remind your kid to think about all of them!
Weigh investment options
If your kid’s bank offers its own robo-advisor platform with reasonable fees and good return rates, it can be simpler for them to invest their money there and manage it from the same site they already use to do their banking. If their bank doesn’t offer a product that fits their needs right now, they can check out other platforms that may have the specific robo-advisor investing options they’re looking for (like financial planning, socially responsible investing, or no minimum principal investment amount).
Robo-advisors provide a good option for young investors who are new to financial investment products, but they’re just one option among many. Wherever your kid decides to invest their money, Mydoh is here to provide you and your children with the information and tools you need to make smart financial decisions that will set you on the path to savings success.
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This article offers general information only and is not intended as legal, financial or other professional advice. A professional advisor should be consulted regarding your specific situation. While the information presented is believed to be factual and current, its accuracy is not guaranteed and it should not be regarded as a complete analysis of the subjects discussed. All expressions of opinion reflect the judgment of the author(s) as of the date of publication and are subject to change. No endorsement of any third parties or their advice, opinions, information, products or services is expressly given or implied by Royal Bank of Canada or its affiliates.