Hello and welcome to Investing With Robots! Today is part 3 of our series, “The Robo-Advantage.” I’m taking some time to write about some of the fundamental, often overlooked advantages of robo-advisors.
In fact, so many robo-advisors offer these features as part of their basic packeges, it’s easy forget how powerful they are. Ultimately, these are the tools that give robo-advisors an edge on traditional advisors.
If you missed either of our first entries, check out out Part One: Fractional Shares and Part Two: Constant Monitoring. Today’s topic, automatic re-balancing, goes hand-in-hand with constant monitoring, so let’s get started.
What is Re-balancing?
Automatic re-balancing is the act of aligning the investments in your Portfolio with your target allocation.
To best get a feel for how and why this might happen, let’s go back to when we were first building our portfolio.
When setting up a portfolio with a robo-advisor one of the first steps is to determine your ideal mix of asset classes. This is referred to as your target allocation.
Over the lifetime of your portfolio, this target allocation should yield the very best results. But lots of variables can knock your allocation out of whack.
When Does Re-balancing Occur?
There are three major events that are likely to trigger re-balancing of your portfolio:
- An investment out/under-performs the rest of your portfolio
- A stock pays dividends to your account
- You make a deposit or a withdrawal from your account
When your robo-advisor runs into any of these situations, assets will be bought or sold to bring your portfolio back into line.
By constantly monitoring your portfolio, robo-advisors are just waiting for an asset class to drift out of line. This can happen as one market segment performs better or worse than the rest of your portfolio.
Once the stray investment passes a minimum threshold, the advisor will trade just enough of the investment to bring your portfolio back in order.
The same goes for each time an investment pays out a dividend or you make a deposit or withdrawal. Your robo-advisor invests these funds in a way that realigns your portfolio with its target allocation.
It’s not a difficult technological feat, but robo-advisors have managed to boost it’s money making potential considerably by performing all these trades for free.
That’s a Lot of Free Trades!
The most impressive fact about this feature has to be that all of these trades are performed for free. Trades on typical online investment platforms can be pricey, sometimes costing upwards of $10-15.
Even if you don’t trade much, those fees can really add up. According to Nerdwallet, your everyday investor doesn’t quite reach two trades a month. “Even at that pace, a $10 trading commission each time could cost as much as $240 a year.”
Robo-advisors don’t charge for any of these additional trades and that means huge savings not just because you’re keeping your portfolio in check, but because robos do it better and for less.
Traditional advisors often bury these trading fees in the fine print of your agreement meaning you’re paying for trades on top of their management fees.
If you were to compile and maintain these assets on your own, performing the trades with a trusted online brokerage, it could eat into a massive chunk of your earnings, especially with smaller portfolios.
The Bottom Line
Automatic re-balancing is a valuable service provided by robo-advisors as part of their regular management. It is performed very efficiently, springing into action when your portfolio drifts away from its target allocation.
Traditional advisors may offer this service in some way or another. Sometimes it is delivered at set intervals, (quarterly and bi-annually are common) but it’s unlikely to occur automatically. If automatic re-balancing is offered (much like some other robo-advantage items) it’s likely you’re adviser is the one using the robot.