While commonly referred to as “robo-advisers,” they are also known by different names. The SEC has referred to robo-advisers as “automated investment tools.” FINRA refers to them as “digital investment advice tools” or “digital investment tools.” FINRA breaks down digital investment tools into two categories: “financial professional-facing” tools (tools that financial professionals use) and “client-facing tools” (tools that clients use.) “Client-facing tools” are referred to as tools that manage an investor’s portfolio by offering on or more of the following services:
- customer profiling,
- asset allocation,
- portfolio selection,
- trade execution,
- portfolio rebalancing, and
- tax-loss harvesting.
Each one of these services can be offered individually, but any combination of one or more of these six activities are referred to as “robo-advisers” or “robos” by FINRA. Learn more about each service below:
- Customer Profiling – This term is used by FINRA to describe FINRA’s Suitability Rule (FINRA Rule 2111) and Know Your Customer Rule (FINRA Rule 2090). Together, these rules require firms (as well as brokers, financial advisers and financial consultants) to have a “reasonable basis to believe” that a particular transaction or overall investment strategy is appropriate for the investor. This reasonable belief can only be formed after the firm, broker, financial adviser or financial consultant gather at least 9 key pieces of information, to create a customer investment profile, ensuring that the client gets the investment advice best tailored to fit their needs. Click here for more information.
- Asset Allocation – This (asset allocation) is the percentage of your total portfolio that you invest in different asset classes, like stocks, bonds, cash or cash equivalents. Financial services companies will adjust your asset mix based on assessments of the current market environment.
- Portfolio Selection – The portfolio(s) a robo-adviser compiles is based on the robo-adviser’s view of client’s risk tolerance and robo-adviser’s approach to investing (It may use a passive, index-based approach to investing, common based on Modern Porfolio Theory or it may incorporate actively managing the investment portfolios).
- Trade Execution – The process of filling the order after the broker has placed an order to buy or sell stock. Read more here.
- Portfolio Rebalancing – The process of changing your portfolio back to the original asset allocation mix. Learn about the different ways you can rebalance your portfolio according to the SEC here and FINRA here.
- Tax-Loss Harvesting – This is typically a tax deferral strategy where any losses on investments are used to offset and reduce taxes on investment gains.
As you can see, these are all important components of an investment account. Before selecting a robo-adviser, it’s important to know about each of the six services as each service can be performed on a spectrum: on a scale from 0, where the company does not offer the service at all, to 100, where the company takes full responsibility for actively managing and providing the full service. Even if you have already selected a robo-adviser, it is helpful to know the different services your company is offering to ensure that you are fully informed and satisfied.