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What's better: robo-advisors or good old fashioned human beings?

Is a robo-advisor better than a human one? (CNBC)
Is a robo-advisor better than a human one? (CNBC)

It’s the hot new debate: do you invest your money through a robo-advisor, or seek out a human one to take care of your investments?

Traditionally, a flesh-and-blood advisor sold you mutual funds and managed the buying and selling within that portfolio. But robo-advisors like Wealthsimple (the trendy, millennial-grabbing platform which features celebrities in its ads) or Betterment (“the smart, modern way to invest”) are gaining popularity in recent years. They go through a client’s risk assessment and then provide the client with access to a diversified investment program that’s quick to set up and done so at a low cost, generally lower than those associated with mutual funds.

Regardless of the route you choose, there are upsides and downsides. And as it turns out, maybe we shouldn’t call these algorithmic managers “advisors” at all.


What’s in a name?

“Robo-advisor is not a good name since there is no advice other than an investment,” says Ed Rempel, a certified financial planner and chartered accountant with over 25 years of experience. “The financial industry is full of people that call themselves financial planners but don’t provide proper financial plans. Robo-advisors are also guilty by having advisor in their name. They should be called robo-investors.”

Darryl Brown, a CFA charterholder and independent financial advisor in Toronto, agrees that even before diving into what these robos can do, understanding the way we position them is important. Brown, who worked at Sun Life Investment Management for seven years and three years at DBRS previously, says robo portfolio managers is a more appropriate title.

“There is an element to what they’re communicating that they doprovide advicewhich customers may or may not actually get with robos,” says Brown.

The pros of robo-advisors

Using robos is a straightforward investment option: investing is simple and online setup is quick, and for those that don’t have complicated needs a robo-advisor can provide a direct avenue to investing.

“Some users say their main investment concern is being able to invest with three clicks or less,” says Rempel. Gone are the countless forms that once needed to be filled out and instead clients can be setup in minutes, which is an attractive option to many.

Robos offer both active investment approaches and passive approaches and give clients more choice.

“Some robos offer investment options and services that feel similar to conventional high net worth advisors, others are geared to younger investors and have options such as socially responsible investments (SRI),” explains Brown. “Some offer non-investment products too such as insurance or group RRSP’s.”

Robos are generally less expensive than mutual funds and provide a lower investment fee compared to mutual funds. Some robo-advisor management fees can be waived, too, says Brown. An investor can place a $5,000 balance and may receive a discount (a quick incentive for some) while other robos may cut a break for those with larger accounts, accounts over half a million for example.

Robos give clients access via desktop or mobile, allowing investments to be easily managed anywhere. Clients are presented with a visually appealing platform that provides “motivating illustrations on their screens such as showing the potential growth of an automatic monthly investment,” says Rempel.

“They have great websites, great on-boarding experience and appeal,” adds Brown, and their branding certainly helps attract people. Take a look at Questrade Portfolio IQ ‘s advertisements which see disgruntled Canadian investors challenge traditional financial advisors, demanding to know why they’re paying so much and their payout is so low. A robo’s branding plays a big role in how they are positioned to the public, more so, how they attract new customers and beginners in the field.

“Mutual funds fees have not changed in decades and it wasn’t a problem when investors were earning 10, 12 per cent, but now investment returns have kind of eroded to middle to high single digits and those mutual funds fees can take away 30, 35 per cent of an investor’s return,” says Brown.

The cons

Since these are pretty straightforward platforms, robo-advisors really only do broad index investing. Anything beyond this, investors needing more assistance and advice for example, is often beyond what is achieved through a robo-advisor.

“I have seen some robo-advisors with popular, but over-valued concept ETFs such as “smart beta” or “low volatility” or dividend ETFs; they seem to been there because of their popularity and of course, led to underperformance,” says Rempel. “I suggest to avoid robo-advisors with anything other than broad indexes in their holdings.”

Being so accessible can be problematic, especially when handling emotional responses to investment news which can lead to rash decision making.

“Being a successful investor is not only matching your portfolio to your risk assessment profile but matching to your emotions too,” says Brown. “What is a benefit is also a con. Having access to your long-term investments at your fingertips, right next to your Instagram or YouTube app, can set people up to make irrational short-term decisions that could disrupt accomplishing their long term financial objectives.”

While robos generally offer a lower-cost way to invest, Rempel suggests that for the level of service being provided, the cost of robos is in fact quite expensive.

“They are mainly an asset allocation service, which typically cost 0.1 per cent not 0.5 per cent. At 0.5 per cent a robo’s cost is half of a full service financial planner (usually 1 per cent according to Rempel) that can provide comprehensive financial planning, retirement planning, tax advice and preparation, cash flow and debt advice, quality investmentsadvice in all areas of a customer’s finances,” explains Rempel.

Some investors aren’t comfortable putting all their trust in an online platform, and prefer an in-person advisor. Having a trusted advisor that possesses an actual human voice and empathy is necessary for some investors, especially in stressful market crisis situations and when making vital investment decisions.

The future of robo-advisors

Critics of robo-advisors don’t see the move to algorithmically-managed funds ever fully replacing humans in a brick-and-mortar location.

“Robo-advisors do not have a very profitable business model; they have been focusing on the unsophisticated side of the DIY market,” says Rempel. “The DIY market is small in Canada with perhaps only about 10 per cent of the industry, and the more sophisticated DIYers will pick their own stocks or ETFs. This leaves robo-advisors with mostly millennials as their main market, which is a lot of small accounts. They are also in a race to the bottom on fees, I think most robo-advisors will not survive this business model.”

However the industry is innovating, and developing a more sustainable long-term model.

Rich Guerrini, CEO of PNC Investments points out that the industry is seeing a transition “from pure play robos (fintechs and new entrants), to large, well-recognized firms that are deploying robos as part of an overall suite of solutions.

“Some smaller ‘one trick pony’ robo firms will not survive long term due to high client acquisition cost, because of minimal brand recognition, lower AUM (assets under management), and clients leaving due to poor customer service,” says Guerrini.

Some robo-advisor companies have started to employ hybrid strategies, partnering with fee-for-service financial planners to manage investments.

“I work with a robo-advisor so that clients can get a GPS for their life in a financial plan from me and then have a robo-advisor as one of the investment options,” says Rempel.

Combining both robo and human connections to investing can ease an investor’s mind, providing more resources and support.

“Some robo-advisors now offer a ‘professional version’ that uses the robo platform with a financial advisor and invests with a portfolio manager,” says Rempel. “So far, it is not the top portfolio manager and the choice is limited, but the real power of robo-advisors is their ease of use, not the quality of their investments. Adding professional investors can make ‘above index investing’ possible and broaden the appeal of robos to higher net-worth clients.”

A good number of robos have target date portfolios, so you can invest your money for a certain length of time, and as you get closer to your target date, it automatically adjusts and your holdings become more conservative. Combining this with the aid of a financial advisor, who can break down numbers and options for you and coach you with your assets, provides the best of both worlds.

Is it right for you?

Before jumping into the world of robo-advisors, ask yourself some fundamental questions:

  • Will I benefit from financial planning, tax or other advice that I can get from a financial planner?

  • Can I motivate myself to follow my plan consistently and avoid emotional investing?

  • Am I comfortable picking my own ETFs?

  • Do I want more growth or a more aggressive portfolio than robo-advisors offer?

  • Do I need to talk to someone directly when I get jitters about the market?

  • Is my investment portfolio something I think about twice a year? How important is it to me, therefore how much attention and assistance do I require in order to manage accordingly?

  • Will I require additional financial planning services or feel like my financial needs would be better met with a dedicated individual? Working with a fee-based financial planner in addition to using a robo to manage investment may be a good solution.

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