When you hear the term “robo advisor” and see many of the advertisements that have pervaded Canadians’ social media feeds, you couldn’t be blamed if you believed that this was another “Millennial fad” or some “online thing” aimed exclusively at young people.
The truth is that while Millennials are obviously the primary target for most of the robo advisors that are emerging as market leaders, we have had many supportive comments come from Gen Xers and even Baby Boomers over at our Canadian Robo Advisors Guide. Interestingly, while young people might be attracted to robos because of their convenience and shiny online platform, it is the older generations that have more investable assets – and consequently a lot more to save when it comes to the commission-based structure of traditional investments versus robo advisor costs.
Why Commissions Matter
If you and your significant other are 40 years old and you’ve managed to put away $100,000 into your investment nest egg over the years, you are likely paying somewhere in the neighborhood of $2,500 per year for investment advice in Canada if you subscribe to the traditional mutual fund commission advice model. That 2.5% drag on your compounded returns is going to really affect the long-term status of your balanced portfolio.
Let’s say we take this hypothetical Gen X couple and we project for them to save a combined $10,000 per year going forward. (Admittedly, that’s a high number, but hopefully at 40 our King and Queen have paid down some of the large early-life debts and are well on their way to climbing their respective salary ladders at work.) If they were to invest through robo advisors and take advantage of commission rates in the neighborhood of .4% per year, they’d end up with a combined nest egg of around $750,000 (assuming a 5% rate of return). If they stick with their Big Bank Funds (and I’ll be very conservative with the commission here) our young-at-heart 65-year-olds would be looking at a much more modest nest egg of roughly $580,000. That’s $170,000 in overall returns that evaporated over the 25-year period . And that’s of course assuming our Gen Xers want to retire at 65 – which may become increasingly rare.
Getting Used to a Different Advice Model
So clearly there is a raw dollars case to made for the lower commissions associated with the robo advisor model at any age. The remaining issue for a lot of people is the idea of trusting their money to something vaguely referred to as a “robot”. This misconception is the unfortunate result of very poor branding. The only thing “robo” or done automatically (without a human executing every single step) is the actual purchasing and selling of broad-based index ETFs. Literally every other step is handled by a human being.
- When you initially contact a robo advisor you will chat with a human being.
- When you decide on what your investment portfolio’s asset allocation will be – it will be with the guidance of human being, using human-created resources to determine your risk profile.
- If you have questions about investments, costs, commissions, or whether to use an RRSP or a TFSA – those will be answered by a human being.
Literally the only aspect of a robo advisor that will not be handled by flesh and blood people is the rebalancing of your investment portfolio back to the asset allocation that you initially set up.
It’s also worth mentioning the any advice that you receive from a major robo advisor in Canada will be held to a higher legal standard than that of someone who merely calls themselves a financial advisor. This odd circumstance is a result of the fact that the major robos are all certified as portfolio managers. This title means that they have what is known as a fiduciary duty when they give advice – basically whatever they recommend has to be in your best interests as the client. It might seem crazy, but this same standard does not apply to many people that deal with Canadians’ finances everyday. Next time anyone gives you financial advice – whether they are with a well-known Canadian Bank or credit union – ask if they have a fiduciary responsibility to you. If they don’t, they are free to sell you whatever products they wish and they cannot be held legally responsible – even if those products are a terrible fit for someone in your position (and that are usually accompanied by a nice little kickback).
Now, all of this being said, all of the robo advisors purport to give financial advice to varying degrees. For most Millennials, financial advice is pretty straight forward. Pay down high interest debt, pay yourself first, save a solid chunk, invest for the long haul. But many Gen Xers and Baby Boomers have somewhat more complicated financial needs due to having more assets and shorter investment horizons. I recommend simply leaving your investment choices to a robo advisor – and your financial planning to a financial planner.
This might sound counterintuitive. Most Canadians still receive “financial planning” across Canada “for free” (or at least that’s what they are told before they are asked which high-fee mutual fund they want to buy that year). For folks with a significant amount of assets, they could easily be paying $20,000+ in commissions each year for advice that could be summed up as, “Let’s continue on the same plan as before, but buy more mutual funds this year.” What I recommend instead is paying for financial planning like you would any other service.
When you go to a lawyer you get an upfront quote right? When you see an accountant they tell you how much it will cost to file your taxes for that year? If you leave your investments to a robo advisor, you can get excellent financial advice at a flat rate from a fee-only financial planner. This planner’s only concern will be your financial plan (what a novel idea) instead of trying to sell you investments. I think that this robo + specialist option is a much better way of getting unbiased financial advice – and it is almost guaranteed to produce better investment outcomes over the long term as well due to the basic math behind index investing vs active investing.
Determining if Robo Advisors are Right for You
Perhaps you’re the type of person that likes to a read several personal finance articles every week and is comfortable handling their own DIY portfolio. In that case, you’ll probably be just fine without a robo advisor. The problem is that most Canadians don’t fit into that category. Instead, many Canadians continue to muddle along with the traditional setup of an under qualified financial advisor that is paid largely based on what terrible investment products they recommend, as opposed to how well they plan your finances. Many of these Canadians are intimidated by the idea of opening up their online brokerage account and buying ETFs to create their own portfolio. For this large group of people, robo advisors might represent the perfect balance of paying for advice, but still keeping most of their money working for them. If you want to read more on the topic or want help deciding which of Canada’s robo advisors are right for you, head to YoungandThrifty.ca where we have in-depth reviews of all of Canada’s robo advisor options.