How the robo-advisor works

The task of the robo-advisor is to provide the investor with a risk-appropriate investment proposal “at the click of a mouse” based on the current technical possibilities and the findings of capital market research. The trend, which has also arrived in Germany in recent years, has resulted in a large number of start-ups. Innovative banks also offer robo-advice.

The way the robo-advisor operates can be roughly divided into five phases:

  1. Consultation with the investor
  2. Strategic asset allocation
  3. Tactical asset allocation
  4. Fulfilment
  5. Rebalancing

First, the investor is invited to answer questions about their investment. The questions are aimed at finding out the desired investment or savings amount, the required investment period, and the investor’s willingness to take risks. Occasionally, the robo-advisor will also attempt to assess the investor’s risk-bearing capacity.

The robo-advisor’s algorithm then determines an investment recommendation, which essentially consists of an allocation of the investment or savings amount across different asset classes (strategic asset allocation).

Most robo-advice providers in Germany give substance to the investment proposal (tactical asset allocation) on the basis of cost-effective index funds in the form of exchange-traded funds (ETF). In the case of active strategies, this also includes issues concerning timing or market/situation-related changes to the strategic allocation.

Fulfilment can be handled by the investor in their securities account by placing corresponding buy orders, although most providers relieve the investor of this task by adding further automation steps. They carry out onboarding and book the securities into the investor’s securities account. 

As part of the rebalancing process, a check is made after some time to see whether the composition of the securities account still corresponds to the target allocation determined in step 2. Price changes can cause changes in the asset class allocation over time, which can be offset by way of rebalancing. As a result, the original allocation proposal is periodically restored. It may also be useful to go through the questions from step 1 again.

Robo-advice is often offered in Germany today in the form of digitalized asset management. In such cases, the investor does not make independent purchase and/or sales decisions themselves after a strategic investment proposal has been settled on, but leaves the tactical and operational structuring of the investment to the digital asset manager.

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