Robo advisors are touted as a low-cost alternative for those who can’t – or don’t want to – pay for the services of a human wealth advisor. While the technology can help build some discipline and provide some insight, it may be some time before it can provide investors with the insight and support a person can.
Robo advisors are becoming an increasingly interesting concept to people used to handling most of their affairs online.
For those who stay in touch, bank, grocery shop and book taxi trips online, the idea of having a digital financial advisor may seem like the logical next step.
But while buying a scarf online may be generally risk-free, is it equally safe to trust your financial future to a robot?
To answer that question, you need to first understand what a robo advisor actually is.
At its most basic level, robo advisors are online wealth management tools that give you automated advice based on an algorithm, or formula.
The program will ask you to answer several questions to determine what your goals are and how comfortable you are with risk, and use your feedback to build a portfolio.
While some programs involve an online advisor or combine one with the algorithm, others don’t have a human financial planner involved.
One of the main advantages of robo advisors is that they come with lower portfolio management fees than you would pay a real-life person, but because a robo advisor’s feedback is based on historical data inputted into an algorithm, you end up with a passive strategy that tends to be backwards looking.
Robo advisors initially came to prominence in the U.S., with companies like Betterment and Wealthfront leading the digital charge.
In early 2015, the Bank of Montreal became the first of the big banks in Canada to launch a robo advisor service, called SmartFolio. Canadians can also access robo advisors through independent firms like WealthSimple.
Fees vary among these, with BMO’s SmartFolio, for instance, requiring a minimum account size of $5,000 and charging fees as a percentage of assets under management, starting at 0.7 per cent for the first $100,000.
WealthSimple, meanwhile, offers free accounts for those with less than $5,000 to invest and fees of 0.5 per cent for accounts up to $250,000.
If you went with a full-service broker dealing in mutual funds, you’d usually pay two per cent or more of your holdings in annual fees.
While those fees would be higher, the upside is that a human advisor wouldn’t just look at existing data like the robo advisor, but also do his own research and analysis to make sure you’re getting the most up-to-date advice. A person should also react more quickly to changes in the market – and perhaps more importantly – hold your hand and remind you to stick with your current investments when the market takes a sudden dip.
An expert can also get to know you and come up with a plan that takes your level of risk tolerance and overall goals into account. And he would deal with things like taxes and estate planning.
That’s not to say robo advisors can’t be valuable tools. These programs can help you develop investing discipline if you are new to the markets, especially if you are part of a younger generation used to interacting online.
They can also be a good option for people who wouldn’t typically be able to afford a financial planner or who don’t have enough wealth to be serviced by one.
But it’s still unclear if these electronic advisors can properly gauge someone’s risk tolerance and how clients can really compare the value of each platform.