Advisors-What are Online Financial Advisors

Automated Investment

One of the most identifiable characteristics of an Online Financial Advisor (OFA) is the automation of the investment or planning processes. Computer programs do the work of financial planners and financial advisors. This article describes the typical process that is used by automated OFAs that want to invest your assets in the securities markets.

What About You?

The automated process starts with an online questionnaire that is used to select a model portfolio. There is no advisor who asks these questions and records your answers. The questionnaires are online and most of them ask for the same information:

  • Ages for you and your spouse
  • Investment horizon expressed as years to retirement
  • Purpose of the assets: Retirement, education fund, 2nd home, security
  • Risk tolerance based on previous experience, curcumstances, and goals
  • Return objective that will enable you to achieve your financial goals   

Model Portfolios

Money managers do not like the word "model" because it implies a cookie-cutter approach that plugs investors with the same characteristics into the same porfolio (the model). However, that is exactly what is happening. Your responses to the above questions plug you into a model:

  • 35 and under investors may go into Maximum Growth (100% stocks)
  • 36 to 50 year old investors may go into Growth (75% stocks; 25% bonds)
  • 51 to 65 year old investors may go into Growth & Income (50% stocks; 50% bonds)
  • 66 to 80 year old investors may go into Income (25% stocks; 75% bonds)
  • 81 and over investors may go into Capital Preservation (0% stocks; 100% short-term bonds)

The OFAs standard assumption is your tolerance for risk (exposure to the stock market) declines with age. This is a valid assumption although older investors can select model portfolios that are designed for younger investors - and vice versa.

The OFA plugs you into the model portfolio that best fits your questionnaire responses. The portfolio already exists much like a mutual fund already exists. Your assets are invested the same way everyone else's assets with the same characteristics are invested. This is a very efficient process for OFAs who manage a small number of portfolios with the same holdings.

ETFs and Index Funds

Most of the OFAs will invest your assets in Exchange Trade Funds (ETFs) that are index funds (S&P 500) that trade like securities. The exchanges make trading ETFs fast, easy, and cheap. The alternative are Index Funds that are managed by mutual fund families.

The role of the ETF is to match the performance of the market as represented by a particular index. For example, an ETF mirrors the performance of the S&P 500 (large capitalization U.S. stocks). This is a "match the market" approach and not a "beat the market" approach. Match the market strategies are lower risk and less expensive than beat the market strategies.

Bells & Whistles

The number of programmed bells and whistles vary by OFA. Some OFAs have more computer programs than others:

  • Automated Rebalancing: Your portfolio is automatically rebalanced to original allocations
  • Tax Efficient Investment: Low turnover, passive investing can reduce taxes
  • Tax Loss Harvesting: Computer programs automatically sell investments that have declined in value

Paladin Says.....

OFAs, mutual fund families, and financial advisors can invest your assets in ETFs. They charge a broad range of fees for their advice and services. OFA services are too new to determine if their computer programs produce better results than the knowledge and advice of high quality financial professionals.  

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