How Robo-Advisors Handle Market Volatility

Market volatility often strikes fear into investors. When prices swing dramatically up or down, the added risk and uncertainty can trigger emotional reactions that lead to poor investment decisions. Nevertheless, volatility can be used by levelheaded investors to capture gains.

One key to managing market turbulence is to stick to a systematic investing approach. While this can be challenging for individual investors, robo-advisors are designed to remain disciplined when the markets become particularly volatile.

How Robo-Advisors Approach Market Volatility

Robo-advisors are a type of financial service that provides automated strategies to manage investments on your behalf. Contrary to their name, humans design and manage these tools—many robo-advisor platforms also have an upgraded service that grants you access to human advisors—but their day-to-day processes are digitized and algorithm-driven.

When market volatility hits, robo-advisors have several major advantages. They use historical data and algorithmic models to identify market patterns and respond to price movements without the emotional bias that often derails individual investors. Their systematic approach means they can make rebalancing decisions, adjust your asset allocations, and work to avoid risks based on preset rules rather than gut reactions.

The timing and frequency of these adjustments depends on the platform you use. Some robo-advisors monitor and rebalance portfolios daily or trigger automatic changes when certain thresholds are met, while others follow monthly or quarterly schedules. This systematic approach helps ensure that investment decisions remain aligned with your long-term goals, even when short-term market chaos might tempt you to abandon your long-term strategies.

Automatic Rebalancing: Keeping Your Portfolio on Course

Most robo-advisors use modern portfolio theory or a similar approach to rebalance your holdings during market drops and surges. So, if you’ve decided you want 70% of your money in stocks and 30% in bonds, the robo-advisor should maintain that split no matter what happens to your specific investments.

These platforms often do this through calendar rebalancing—periodically reviewing the weights of different portfolio components and buying or selling as needed to bring the portfolio back to your target allocation. In particularly volatile periods, robo-advisors might also use threshold-based rebalancing with “rebalancing bands”—preset ranges that trigger automatic adjustments when your portfolio drifts too far from its targets.

For example, suppose your portfolio is supposed to hold 25% in technology stocks, with a tolerance band of plus or minus 5%. If tech stocks surge and grow to represent 31% of your portfolio (or drop to 19%), the robo-advisor automatically moves to bring your tech allocation back to the 25% target.

Automatic rebalancing helps ensure that your portfolio stays at the right level of risk for you.

Tax-Loss Harvesting and Other Automated Responses

Volatility can also present opportunities, especially since you can use any losses to your advantage. Tax-loss harvesting is a well-known strategy that is especially useful in periods of market downturn or when the price of a security within a portfolio has fallen. When one of your investments loses value, you can sell it to “realize” that loss on paper, then use that loss to offset gains from your winning investments. This reduces your overall tax bill while keeping your portfolio balanced.

Robo-advisors often automate this task, determining when to sell off assets that have incurred a loss to maximize the tax benefits. This is a tremendous advantage of robo-advisors over human portfolio management—not only is tax-loss harvesting a time-consuming process, but humans are also prone to errors that may cost you money. Robo-advisors can also ensure you’re adhering to wash sale rules, which prohibit you from harvesting a loss in an asset that you then replace with a very similar one.

What Investors Should—and Shouldn’t—Do During Volatile Markets

Regardless of whether you employ a robo-advisor to manage your portfolio, it’s essential to have a strong plan in place, guided by your tolerance for risk and financial goals, and to stick to it even as the market shifts.

Here are some practical tips for what to do—and what not to do—when the market becomes volatile:

• Avoid panic selling: Resist the urge to try to flee from the market volatility by selling off assets that have declined in value. Over the long term, these assets may very well rise in price again, so you’d be selling at the worst time (a market bottom).
• Don’t try to time the market: Trying to do so is highly risky most retail investors. Remember that past results are not an indicator of future performance.
• Stick to the plan: If you have a system in place that governs your investments—such as dollar-cost averaging—stick to it even when the market becomes turbulent.
• Ensure you’re diversified: When one sector takes a big hit (or soars), it can knock your portfolio off balance. Make sure you’re still spread across different types of investments according to your original plan, and remember to rebalance when things get too lopsided.
• Stay in line with your risk tolerance: When markets get bumpy, don’t let fear or greed push you off course. If you were fine with moderate risk before the volatility hit, don’t suddenly change your game.

The Bottom Line

Robo-advisors are popular tools for managing portfolios, particularly for inexperienced investors. A key benefit of robo-advisors is that they follow preset plans dictated by algorithms, meaning they will not be subject to the same type of emotional reactions that a human investor may have to market volatility.

Robo-advisors periodically rebalance portfolios to ensure that they stay in line with target goals, and most services also perform automated tax-loss harvesting, looking for ways to benefit you tax-wise when possible.