The traditional investment broker that is licensed to manage a portfolio on behalf of a client is considered an institutional investor in the sense that they have attended some type of formal education, be it a degree for business administration, economics or finance. They usually work for a bank or some other type of institutional financial entity, like many do on Wall Street. Their job typically consists of meticulous research and attention to detail, together with financial and mathematical modeling that helps them with the process of predictive analysis when figuring out when to buy and sell stocks on behalf of their clients.
This middleman usually would take on a client conditionally – either a minimum initial investment or a monthly rate that is sufficiently high enough for him to be profitable off of the fees alone, in addition to the client agreeing to a minimum predetermined period of time for the investment to stay with the financial advisor, typically 3-5 years or more, in order for their client to reap the benefits. This would sometimes lock the client in a contractual obligation and if they needed the money for an emergency but didn’t set the money on the side for an emergency fund yet were investing with the broker, they would not be able to pull it out when they need it or it might be in a period of some short term loss where pulling it out prematurely before the expiration of the minimum investment period would result in substantial financial losses.
Unfortunately, this type of business model tends to price out the majority of people, even though an increasing number of people have talked to a financial advisor in their bank or through some other institution like a brokerage, who had saved up enough money or make some extra income that they would rather invest than save and this way it wouldn’t depreciate over time like cash by itself typically does. Most are high income professionals who are nearing retirement age and have saved up enough for a nest egg, but would rather it be managed in a more meaningful way. Many young people who would benefit the most from the compound interest and amortization of the stocks, particularly as it pertains to reinvesting profits made on existing sales and market upturns.
Robo-advisors are a 21st century solution that combines the convenience of software solutions, the interconnectivity of the internet and the functioning of artificial intelligence and automated investing that requires moderate to minimal human supervision. Using financial models and mathematical formulas, the robo-advisor is able to be programmed by the institution who offers it to on a full time basis fill out the rule that would typically need to be filled out by a human being versed in economic principles and formulations on a full time basis doing very tedious work.
The ability for the robo-advisor to simultaneously engage millions of people and their portfolio really shows the capabilities of this technology, as now the costs of hiring a full time financial advisor would be cut significantly that it can be profitable for an institution to take on retail investors of all income brackets to invest with them, making money on the collective fees of millions of people who are charged a marginally small amount with no mandatory commitments to some predetermined amount or set period of time that would be the condition of a traditional financial advisor or investment banker.
The algorithms themselves typically used in the design of robo-advisor software are often designed by the joint effort of the individual roles of data scientists, investment managers, programmers and financial advisors. These algorithms tend to be automated and do not need the intervention of a human advisor in order to give advice to a client. The software is meant to utilize it’s algorithms to allocate, manage and optimize a client’s assets depending on the goal – whether the client wants short term and high risk investments or long term and low risk investments, or any combination thereof.
As of October 2017, there are over 100 robo-advisor services in multiple countries, but the bulk of these is in the US, with some in the UK, Germany, Canada and others. They are responsible for managing $224 billion in assets. The robo-advisor market was estimated to reach around $2 trillion by the end of 2020, but due to the COVID-19 pandemic those numbers became skewed.