Robo-Advisors: The Future of Investing?
Traditionally, we have been going to financial planners for wealth management services. These services would range from retirement planning, to saving up for large purchases, such as a down payment on a house. Robo-advisors have been ‘disrupting’ this traditional model of financial planning, especially among millennials. According to a study from Wells Fargo, only 16% of millennials claim that they work with a financial planner – which is half the rate of baby boomers.
Robo-advisors are replacing traditional financial planners/advisors with an automatic investing service. Many wealth management companies have started to take advantage of robo-advisors – some of the most popular Canadian services include Wealth Simple, BMO Smartfolio, and WealthBar.
How Do Robo-Advisors Work
Robo-advisors start with a questionnaire, in order to understand the investor’s objectives. The main objective behind the questionnaires is to understand the risk tolerance, and personal circumstances of the investor. Based on the answers, the robo-advisor provides an automated, algorithm based portfolio recommendation (Investopedia). The portfolio recommendation typically ranges from the three most common investing styles – conservative, balanced, and (equity) growth.
Everyone’s personal finance situation is different. Like financial planners, robo-advisors aim to understand the investor through a pre-determined set of questions. The most common types of questions include, but are not limited to:
- Age – risk tolerance typically decreases as age rises
- Time horizon (for the funds being invested) – higher risk tolerance with longer time horizons
- Income, and current net worth – a lower net worth negatively impacts risk tolerance
- Investment knowledge – a savvy investor would usually understand the concept of risk vs. reward
- Risk vs. return – how much loss can the investor accept in their portfolio?
Low costs and simplicity are the major benefit of robo-advisors, which is certainly a contributing factor of why robo-advisors are attractive to millennials. According to a Goldman Sachs study – 57% of millennials compare prices in store before making a purchase. Robo-advisors typically cost 0.15% – 0.75% of assets under management, significantly cheaper than the 1%+ fees for traditional financial planners. In fact, many mutual funds cost north of 2% – which can be costly in the long term. An investment of $10,000 would cost $2/month at Wealthsimple, and $2.50/month at WealthBar. In general, robo-advising portfolio management services can save up to 90% in investing fees.
Personal life events may not be taken into consideration within the common robo-advising questionnaires. Changing life circumstances include enrollment into higher education, marriage, and a home purchase. Unlike financial planners, robo-advisors may fail to adjust to any life events that would impact your personal finances. This can be solved by changing your investment objectives. For example, if you’re planning on using some of the funds to purchase a home within the short term, it may be wise to ensure you have the money invested in a lower risk asset.
Robo-advisors are algorithm based on previous market data, and the assumptions may be inaccurate for future financial markets (Equities). However, many robo-advisors are passively managed (i.e. in ETFs). Passively managed investments (investing in index funds) are highly recommended by many personal finance experts.
Robo-advisors have definitely been shifting the financial planning industry within the past decade. With low account balance minimums and low fees, investors are benefiting from this new technology. Robo-advisors also simplify the investing process, providing higher transparency – an attractive feature for investors at any stage. Wealthsimple launched in 2014, and has quickly grew to over $400 million in assets under management (The Globe and Mail). The success of Wealthsimple and changing consumer preferences suggest that robo-advising is the up and coming model, replacing traditional financial planners.
Writer: Jelani Smith
Disclaimer: All investing can potentially be risky. Investing or borrowing can lead into financial losses. All content on Bay Street Blog are solely for educational purposes. All other information are obtained from credible and authoritative references. Bay Street Blog is not responsible for any financial losses from the information provided. When investing or borrowing, always consult with an industry professional.