How does automated investing work?

For time-poor investors, automated investing seems like an ideal option. We’ve explored this current trend in investing to figure out how it works and if it’s worth doing?

What is automated investing?

Also known as robo advisors, automated investing tools use complex computer algorithms to automatically invest your money and create an investment portfolio based on your age, income, and the parameters you have selected, such as how much you want to invest and how often. The tool should also consider your risk tolerance, market conditions, and any other relevant factors.

Automated investing tends to be popular with investors who are just starting out and not sure where to invest their money, as well as investors looking for a hands-off solution.

Automated investing with ETFs

Automated investing platforms tend to use exchange traded funds (ETFs) to build investment portfolios, as they provide an easy way to access a range of different asset classes, are generally a low cost option and because they trade on an exchange they are fairly transparent.

For those new to ETFs they are a security that typically tracks a stock index or sector. You can also get ETFs that track a commodity, bond or a range of assets. ETFs are traded on the stock market, when you buy an ETF you are buying shares of a portfolio that tracks the yield and return of its corresponding index or asset.

Automated investing vs. Active investing

If you are looking to have a more hands-on approach to investing, automated investing probably isn’t for you. You may instead suit an active investment strategy.

Active investing requires a hands-on approach, usually requires a high level of confidence when making investment decisions, and would typically involve higher risk, which should definitely be considered. As the object of active investors is to attempt to beat the market, if you are successful with this strategy it can lead to higher than average returns.

On the other hand, automated investing takes the set and forget approach to investing. Often automated investing platforms will even rebalance your portfolio for you, so you may never need to lift a finger. These platforms are typically sought out by novice investors who aren’t confident making investment decisions.

Related article: Active vs. Passive Investing: What’s the difference?

Is automated investing a good idea?

Automated investing has its pros and cons, and therefore doesn’t suit all investors. There are a few benefits of automated investing. For example, it tends to be a low-cost option compared to engaging with a professional fund manager. Also, as investment decisions are made by computer algorithms it takes the emotions out of investing which can helps your investment strategy stay on track. However, this is also the biggest downside, as robo advisors build portfolios based on facts. Therefore, they don’t typically take into consideration any real-life nuances, like your reasons for investing or current circumstances.

Before investing in an automated investing platform you should consider your investment goals and timeframe. If you do decide to go with a robo advisor, make sure you compare the services available, their track record and the fees that they charge. Also, keep in mind that past performance doesn’t indicate future performance.

Cover image source: PopTika/Shutterstock.com