What is a robo-advisor?
How does it function? What algorithms does it use? Set up your account correctly to avoid inconveniences in the future.
Juraj Hrbatý | Our process | 8. October 2019
Finax is a robo-advisor
The first robo-advisors were established in the USA in 2008. Their job is to help small investors and financial agents to choose the most suitable portfolio composition. The majority of robo-advisors recommends passive investing with rebalancing (automized adjustments of portfolio composition).
Labour costs are accountable for the high prices of services. By eliminating these costs, robo-advisors significantly reduce the price of investment services and consequently increase the customers’ net profits.
Finax is the first robo-advisor offering its services in the CEE region. In comparison with our competition in Europe, we have gone much further in terms of customer advisory. We are one of few, if not the only robo-advisor that offers its services also through external advisors – financial agents.
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Moreover, financial agents help clients understand and manage their personal finance. Financial agents also provide long-term assistance with the clients’ finance for a constant fee.
Providing information online and automized processes allow us to offer our services significantly cheaper. We have also published FAQ on our website with the aim of decreasing the workload of our employees, which results in lower fees for our customers.
However, if you have any questions, feel free to call us or write us an email. You can also meet us in person during Finax Mondays or ask your questions during our live webinars.
How do the algorithms function?
First and the most important prerequisite for choosing the most suitable portfolio for you are true answers to the questions that we ask during the investment setup phase. The answers influence the risk profile of your investment; therefore, it is very important to answer them according to your current life situation and plans.
The questionnaire is our only source of information for a correct setup of your investment, which should take tens of years.
Answers that do not correspond with reality can lead to a not optimally set risk of your investment. In case of a market crash, wrongly set risk of your investment can lead to you not withstanding the pressure and closing your position.
Closing a position during a market drop is one of the biggest mistakes that investors make. The ground stone of a successful investment is the abidance of the initially set investment horizon, which is an important variable for choosing the most suitable portfolio for you.
The other way around, false answers can also lead to a too conservative portfolio that will deprive you of higher profits.
Algorithms individually asses your ability and willingness to undertake risks based on the investment horizon, your financial situation, experience and your attitude towards risk. For example, the longer is your investment horizon, the higher is the chance that your investment will result into profit and greater returns even with a riskier portfolio.
The one and a half year that Finax operates has proven that our algorithms are set correctly. We have made no changes to the algorithms since they were launched.
Our clients sometimes want to change their investment strategy. You can always choose a more conservative portfolio, but the algorithm does not allow to choose a more dynamic portfolio.
The reason is that the provided answers indicate that a riskier portfolio is not suitable. In that case, check whether your answers were correct. For instance, a client wants to send 50€ a month and he states that it is his whole fortune.
Average annual return of our 80/20 portfolio (80% equities, 8,57% p.a.) is only 0.4% lower than that of our 100/0 portfolio (100% equities, 8,99% p.a.). However, it bears significantly lower risk (annual portfolio volatility of 80:20 strategy is 14,8%, while 100/0 strategy has an annual volatility of 17,4%). Therefore, the 80/20 strategy achieves higher weighted return.
There are things you should not forget about
1) What if my situation changes?
Finax thought about everything. If your situation changes (e.g. birth of a child or a change in your life plans) or you want to modify your original responses, you can change your answers in the setting section after signing into your account. You can also adjust your investment strategy in the Advisory section. We elaborated on this topic in a previous blog. In any case, we will remind you to reconsider your investment profile once a year, as we are obliged by the law.
2) If you are married
Your answers should reflect on the financial situation of your family. For instance, if the mortgage on your house is just on your wife’s name, that does not mean it has no effect on your financial situation. Married couples have joint liability over financial obligations and joint ownership of money and assets acquired after marriage. You should keep this in mind when making investment decisions.
3) How does investment horizon influence your investment strategy?
The basic rule of investment is that longer investment horizon results in higher chance of profit and higher returns. If you are willing to invest your money for a long period of time, the system may recommend more dynamic portfolio. It also works the other way around. In case you are planning a shorter investment horizon, your investment will be more conservative.
The effect of income and expenses on your investment
One of the basic tasks of robo-advisors is to understand your financial situation. Your ability to tolerate risk depends on types of your income, investment amount, value of your assets and financial obligations. For example, if you decide to invest a significant share of your wealth, the algorithm will not recommend a 100/0 strategy, but it will adjust the risk accordingly.
How to leverage your knowledge and experience?
If you are not exactly sure what is a bond, stock or what is the difference between index ETF and mutual funds, you can learn more by clicking on the corresponding links. If you state in the questionnaire that you know what these securities are, you should also be aware of the risks they bear and what their return composes of. If you owned securities or funds before, or you are part of a private pension scheme and you understand the principles behind them, then you have experience with these financial instruments.
Can I really expect the return, that the robo-advisor forecasts?
We did our best to make our algorithms as precise as possible. Operations of our company are overseen by The National Bank of Slovakia, which means that we have to provide our clients with true, verifiable and provable information.
Our algorithms are derived from statistical data from the past 30 years. We are able to forecast the future appreciation of the client’s investment based on historical data; however, past returns do not guarantee future returns.
The final word in our predictions had our investment board. Therefore, our forecasts are more conservative, than the long-term statistics. In the following chart, you can see indicators of particular Finax portfolios, so that you can get an image of expected risks and potential returns.
Is a modelled annual historical return (after fees and with our rebalancing over the past 30 years).
Expected return p.a.
Is the expected annual return (after fees and with our rebalancing).
Pessimistic return p.a.
Represents the 90th percentile of historic data statistics, which means that you will achieve the stated results with 90% probability on an investment horizon longer than 20 years.
Number of drops > 10%
Number of market drops over 10% for the particular strategy. For example, the 60% stocks and 40% bonds strategy had 5 drops larger than 10% over the past 30 years. The maximum drop over the past 30 years was 33.4%.
Robo-advisor was made by humans
All in all, Finax is a robo-advisor. We recommend and manage customers’ portfolios with a minimum of human interventions. We provide our services based on mathematic rules and algorithms, which we created and regularly optimize.
We do not contact the client unless he/she requests it or it is necessary. However, it is important to say that all the algorithms and processes were completely designed by Finax with the help of our team of experts.