Technology seems to touch every aspect of our lives these days, from electric toothbrushes, to robotic vacuum cleaners, to online dating; it seems that we are quite comfortable to place many of life’s most mundane tasks in the hands of machines. But are there certain tasks that that still require a human touch?
Investing and managing money might seem like one such task that requires a large amount of personal attention and professional advice. However, an increasing number of investors have started looking to technology to help manage their money. This trend has seen the rise of a new breed of wealth manager – “the robo-advisor.”
What is a robo-advisor and who do they serve?
Robo-advisors, or to be more accurate, algorithmic investment services, represent a fast-growing segment of the investment advisory market. In the U.S. companies such as Betterment, Wealthfront and LearnVest are well established players in the robo-advisor market, while here in Canada Nest Wealth, led by BNN anchor Randy Cass, has entered the market offering customized ETF portfolios at a fixed fee. Using complex automated techniques to provide clients with computer-assisted investment advice and financial planning, companies can offer investors a low cost alternative to traditional flesh and blood advisors. By replacing people with processors, robo-advisors can reduce some of the overhead costs typically associated with providing financial services.
This new business model is filling a gap in the financial investing industry by providing those individuals with smaller account sizes with access to professional financial services. Up until now, many traditional financial organizations ignored what some consider a less profitable cohort, preferring to focus their attention on larger, more affluent clients.
Providers of automated advisory services offer various fee structures and account restrictions, although almost all are inexpensive in comparison with other traditional investment advisors, which can charge as much as 1-2 per cent of asset value.
What are the risks?
Robo-advisors use sophisticated software to analyze client needs by feeding information into a system that provides results which form the basis for investment planning and financial advice. Typically, individual investment plans are created by inviting investors to answer a series of online questions, which help frame a client’s overall investment goals and tolerance to risk – all without the aid of human interaction.
To get the most out of this approach, investors must understand their financial objectives, level of risk tolerance and investment constraints. Of course many novice investors rely on their advisor to guide them through these introspective questions, which raises the question of the true utility of such an automated service.
This is particularly important when you take into account the fact that an algorithm may be able to determine a person’s financial ability to take risks, however, relying on an algorithm to determine a person’s emotional ability to take that risk is something very different indeed. It could easily be argued that only a human advisor can provide this level of insight. Underestimating the influence of emotions on investment decisions can be a mistake – rightly or wrongly, our behavioural biases can have a direct impact on the investment decisions we all make.
What does the future hold?
Robo-advisors present an exciting new opportunity to those companies looking to take the next step in financial management services, but is it a positive step forward for investor? Every new technology comes with its own set of possibilities and limitations, and consumers should educate themselves on both. Getting the most out of these platforms will require some self-analysis and review of product offerings from the companies’ involved.
During a panel discussion at this year’s CFA Institute Annual Conference, Fortigent’s Chief Investment Officer Scott D. Welch discussed the rise of automated financial services and the potential impact on the industry. In particular he noted the appeal that such platforms have with Gen X and Y who “speak technology as their native tongue.” For this tech-savvy audience, robo-advisors are just another online service, naturally aligned to their lifestyle of instant access and convenience – something traditional advisors will have to adapt to in the coming years.
Although there is little question that we will see an increase in robo-advisor services offered over the coming years, the big question facing these platforms is whether they can evolve with their clients over time to provide a truly valuable service.
Will these platforms be able to provide more customized services, access to other asset classes, or more advanced strategies as clients save or invest their way into larger investment accounts? Will they be able to leverage new advancements in behavioral finance, automation, and artificial intelligence (AI) to compete more effectively with traditional investment advisors?
It is also important to ask how automated advisors would deal with a flash crash in the market or a major financial crisis like we saw in 2008-2009. It’s one thing to manage money in a calm market on an upward trajectory, but can robo-advisors handle the emotional turmoil associated with volatile returns? In that scenario, having a live human advisor on speed dial might still have its advantages.
All posts are the opinion of the author. As such, they should not be construed as investment advice, nor do the opinions expressed necessarily reflect the views of CFA Institute or the author’s employer.