Over the past few decades, the digital revolution has empowered retail investors like never before. The average person with access to the internet can review their portfolio from the comfort of their home and even buy and sell stocks or obtain professional advice.
When investors envision digital investing, two options are likely to come to mind:
Online brokers enable individuals to take significant control of their portfolio management, buying and selling investments at the time of their choosing. Of course, with this level of flexibility comes the responsibility to ensure sound trade decisions.
This requires research and time, something most people are short on.
A more recent innovation has been the proliferation of robo-advisors, relatively hands-off investment management that performs trades on your behalf, typically based on your answers to a questionnaire about risk tolerance, risk appetite, and investment goals.
While robo-advice can be an excellent solution for some people, it’s not without downsides, which we’ll explore below.
As great as online brokers and robo-advisors have been, progress has stagnated. Over the past decade, we haven’t witnessed a substantial disruption to the digital retail investing space.
That is, until now.
Unless you’ve been sleeping under a rock the past year, you’ve likely heard the hype around artificial intelligence, popularized by the release of ChatGPT. No longer is the debate focused on online brokers vs. robo-advisors alone. Instead, platforms like FINQ’s AI-driven stock rankings are a new powerful alternative on the market.
So, how does a platform like FINQ differ from online brokers and robo-advisors?
We’re glad you asked.
When we talk about the financial world and specifically the investment world we have to understand that the service named "brokerage" is at the very bottom of the value chain for the customer. For example, if a person has to travel a long way to have brain surgery, but the transportation to the expert Dr is at the bottom of the value chain. So the same way, digitizing brokerage is nice and important but does not really add much value. Believe it or not, online brokers have been around for over three decades. In fact, the first electronic trading platform hit the market in 1992. However, their popularity didn’t grow substantially until E-Trade launched their platform in 1999, aimed primarily at the consumer.
At its simplest, an online broker is a platform that allows investors to buy and sell securities, like stocks, over the Internet. You can think of them as intermediaries between the market and individual investors.
Typically, online brokerage platforms also provide financial data, analysis tools, and educational resources, helping investors make informed decisions.
Robo-advisors are digital platforms that provide automated, rules-based investment management services. Usually, a platform will collect information about a client's financial situation and future goals using a simple questionnaire. Based on the responses, the robo-advisor will recommend a particular portfolio of investments and weights. Over time, as different assets deviate from their target weight, the platform will rebalance (trade) the account back to the target.
Recently, robo-advisors and online brokers have come under increased scrutiny from regulatory bodies like the Securities Exchange Commission (SEC). They’ve been accused of encouraging investors to trade too frequently using elaborate promotions, colorful graphics, and push notifications.
This reckless trading can result in risky investments and higher trading costs.
“In the last few years, we’ve seen a proliferation of trading apps, wealth-management apps, and robo advisers that use these practices to develop and provide investment advice to retail investors… In many cases, these features may encourage investors to trade more often, invest in different products, or change their investment strategy,” said SEC Chairman Gary Gensler in 2021, according to the Wall Street Journal article written at the time.
The core differences between online brokers and robo-advisors lie in their operation, autonomy, complexity, and the personal investment styles they serve.
Online brokers act as access points to the financial markets, in turn, enabling investors to buy and sell assets like stocks, bonds, ETFs, and mutual funds. This approach is self-directed. It requires investors to perform their own research, analyze market trends, and make individual trading decisions.
In contrast, robo-advisors automate the portfolio management process. After you set your risk tolerance, time horizon, and investment goals, robo-advisors use algorithms to build and manage your portfolio. This hands-off approach means investors have less control over individual investment choices and cannot easily modify their portfolios.