Key things you need to know about Robo-Advisors

Recently I was on my regular visit on Alberta Primetime and we talked about Robo-Advisors.  You can check out the interview here but here are some of the highlights of our discussion

What exactly is a Robo-Advisor?

It’s an interesting title, to say the least.  When I first heard the term, I had visions of these little Robots on an assembly-line, picking out all the good investments and discarding the bad ones.

However, the term Robo isn’t about Robots or even computers running portfolios without any human interaction or involvement.  The term Robo-Advisor really represents a new type of investing that is a little different to traditional models and methods of investing.

The basic premise of traditional money management and investing is that professional money managers can pick and choose stocks that will outperform other stocks or the stock market as a whole.

Robo-Advisors believe that humans are not great at stock picking. This belief is backed up by lots of research that shows very few money managers actually outperform the stock market over long periods of time. When you look at these studies, the evidence suggests that it’s actually the proper allocation of assets that generates most of your investment return, not the specific investment selection.

As a result of this research, Robo-Advisors focus on investing in index portfolios that are very low cost and easy to manage.  Robo-Advisors create efficiencies by keeping fees low, leveraging technology and automation and then adding a small dose of human involvement.

Related article:  Active vs Passive investing

So why would anyone want to go with Robo-Advisors?

From what I see and experience, there are three key reasons why people are drawn to Robo-Advisors:

  1. Lower Fees: If you are tired of paying high fees for retail mutual funds and full-service financial advice, then Robo-Advisors are an attractive alternative. The biggest appeal of Robo-Advisors is they invest money at considerably lower fees; we’re talking 60-80% lower than retail. For example, if you had a $100,000 portfolio, you might pay 2% or 2.5% with traditional retail investments, like mutual funds, but with a Robo-Advisor your management fee might only be 0.5%.
  2. Service Model: The second issue that motivates investors to look at Robo-Advisors is the service (orImage of man teaching, used for article regarding Robo-Advisors lack of service) that they get from conventional Financial Advisors. Some people have become disillusioned with the traditional financial advisor model and complain about lack of service, communication, and attention.  The Robo-Advisor concept is built on a ‘service on-demand’ model where, if you have questions or need some help, you can call to talk to a human advisor at any time but you may not talk the same person every time.  For people who are not ready (or don’t want) to become fully-fledged do-it-yourself investors, a Robo-Advisor may be the next best solution.
  3. Accessibility: The third appeal of Robo-Advisors is they are so accessible. In the same way that online shopping has become massively popular over the past few years, investing online has also become much more mainstream. Robo-advisors offer a simple, online solution for investors and have built a process that is super simple from start to finish. Robo-Advisor companies have come a long way in a short period of time and they are accessible by all investors, regardless of age, portfolio size or the type of account they’re looking for (RRSP, TFSA, RESP etc.).

How exactly do Robo-Advisors manage a portfolio?

Again, the main difference is rooted in the idea of keeping management fees low by investing in the stock market as a whole instead of picking and choosing individual stocks or investments.  Robo-Advisors mostly invest in something called Exchange Traded Funds or ETFs.

Robo-Advisors will then manage the portfolio by rebalancing the assets from time to time.  This is where technology can play a big role in managing money.  Robo-Advisors tend to believe that managing money is more of a science than an art.  They have taken the guesswork out of investing by creating sound, well-diversified portfolios with ongoing management.

Related article:  My portfolio of ETFs

Are Robo-Advisors for everyone?

Definitely not!  When Robo-Advisors first came out, they were considered to be the ideal investment for smaller investors and millennials (who tend to be more comfortable with the online world and new technology).  Personally, I think there is now a much broader appeal.  Many older retirees I talk to are asking about Robo-Advisors and many people with large portfolios who are looking to reduce fees and costs are also forging down the Robo-Advisor route.

Robo-Advisors aren’t for everyone though. There will always be a group of people out there that are what I call the “Do-It-Yourself” investors. Some are day traders and others are couch potato investors and, quite frankly, these people are unlikely to use Robo-Advisors because they’re happy to build and manage their own portfolios.

I also believe there is a significant group of people who like having a relationship with a specific person to help them manage their investments. Many people I meet want to work with a financial advisor because they do not have the time, confidence, knowledge or desire to manage money themselves.  While there are lousy advisors out there, there are still, and always will be, some good financial advisors who are servicing their clients well and delivering great value.

Where Robo-Advisors fit well is when people have lost confidence in their relationships with an advisor or they have not found a good advisor or when they are paying high fees and are tired of not getting any returns from paying those high fees.  These are the people who are looking for change but who are not ready or not interested in becoming a true “Do-It-Yourselfer”.

Related article: Why Robo-Advisors many not be for just millennials? 

What are some examples of Robo-Advisors in Canada?

The Robo-Advisor industry in Canada is small compared to what is happened in the US but it’s growing in popularity and interest.

Probably the biggest and the most well known Robo-Advisor in Canada is WealthSimple.

Other options in Canada include:

Even the banks are into the game: BMO has their Smartfolio investment.

Are Robo-Advisors the future of investing?

I’ve been in this industry for 25 years and I’ve seen a lot of changes over that time. Just like Robo-Advisors, the introduction of ETFs disturbed the investment industry and gave investors an alternative to actively managed portfolios. I think the Robo-Advisor industry is here to stay but they will likely morph and change forms, just like the mutual fund industry has changed over time.

As the investment industry has changed, Financial Advisors have also had to change how they do business.  I doubt Robo-Advisors will necessarily take over the investment industry but I do think they are here to stay and I think they will gain market share because they are a viable option for a segment of investors.

Personally, I don’t have any money with Robo-Advisors but I do think they are worth considering for a lot of people I talk to.  In fact, I am considering them for my kids RESP investments. I’ll let you know how that turns out!

Written by Jim Yih

Jim Yih is a Fee Only Advisor, Best Selling Author, and Financial Speaker on wealth, retirement and personal finance. Currently, Jim specializes in putting Financial Education programs into the workplace. For more information you can follow him on Twitter @JimYih or visit his other websites Group Benefits Online and Advisor Think Box.

3 Responses to Key things you need to know about Robo-Advisors

  1. Great article Jim. I believe there is a very wide potential audience for robo-advisors as well. In my experience, the number of people who are either willing, capable or successful at DIY investing is very small. As you know, investors are often their own worst enemies when it comes to investing and fees are a close second. Robos solve both these problems!
    Steve

  2. I opened with a BMO Smartfolio account and that was a bad idea! They loaded their dud ETF’s and my value continued to sink. Closed and managing myself now – no more robo for me!

  3. Jim a lot people like to dream in the big buck and Robo-Investment appeal to those ones that never are going to make any penny in the market place. Good luck and keep me inform so I want to be aware how tech- investment develop or trending down.

Leave a reply