What you should know about Robo-advisors

Content Producer · 6 September 2021

Original version published by Dominic Beattie.

In recent years, the financial technology industry (fintech) has given rise to automated advice services popularly known as ‘robo-advisors’. These robo-advisors are designed to do part of the job of a financial advisor but at a lower cost and, it is claimed, with more efficiency.

So, what do robo-advisors have to offer?

What is a Robo-advisor?

Robo-advice burst onto the scene a few years ago in the US but has since spread around the world. Robo-advisors are digital platforms built to provide automated financial planning services with little need for human supervision.

It is essentially a computer program comprising complex algorithms and mathematical models that aims to match a client’s risk profile with an asset allocation.

They generally work by asking customers to initially input information regarding their financial status such as their income, life stage, risk profile and how much they have to invest. The program then uses this information to allocate the client’s funds towards particular asset classes with the intention of achieving investment returns that align with their specific goals.

Understanding the role of Robo-advisors

In today’s market, most robo-advisors use indexing strategies, often are passive and adhere to some form of modern portfolio theory. The best robo-advisors offer simple account set up, thorough goal planning, portfolio management, security, personalised customer service, education pieces and low cost fees.

Is robo-advice right for me?

Robo-advisors are significantly lower cost than seeing a financial advisor, and it is a great alternative if you’re looking for advice in only one area (i.e. just advice on what to invest in). Robo-advisors are also much more accessible as they are available online 24/7 and take much less initial funds to get started. Most funds start at a minimum entry point of $10,000, compared to much higher initial client investable assets needed to see a financial adviser in person. If you value efficiency over relationship building, a robo-advisor is certainly worth considering.

For example, if you wanted to create a share portfolio or execute a trade with a robo-advisor, you can easily do so on most devices with the click of a few buttons. If you were to use a financial adviser, you would have to call or meet with them, explain your needs and why you’d like to make this decision, fill out the paperwork and wait until it is processed.

Pros and cons of robo-advice

Robo-advice offers a number of potential benefits to investors but there are a few reasons why they aren’t likely to completely take over human financial planners.

Pros of robo-advice

  • No human error: They take the human emotion and irrationality out of investing and focus on the pure fundamental numbers.
  • Tax efficiency: They may have automatically programmed in measures for tax efficiency.
  • Prompt decision-making: Robo-advice may provide timely reminders to clients when they reach investment milestones and need to make a decision.
  • Lower costs: Robo-advice may be cheaper than having an advisor.

Cons of robo-advice

  • Less options: Many won’t offer the full range of advice services that are typically provided by a financial planner. For example, estate planning, tax planning and a broader range of investment options may not be available depending on the provider you choose.
  • Lack of in-depth insight: Robo-advisors can’t foresee potential risks on the horizon (e.g. housing bubble, RBA rate changes) so you would benefit from doing your own research.
  • No personal touch: Robo-advice lacks a human understanding of personal circumstances and can’t really adapt as much to your life’s changes. By using robo-advice, you miss out on the development of a relationship of trust between advisor and client.

How will robo-advice impact the financial services industry?

So, are robo-advisors a threat to everyday financial planners/advisors? Rather than being a threat, robo-advice might actually be a tool for professional advisors to work with, as suggested by US report Embracing Change as Opportunity. The report says:

“Embracing technology does not mean replacing human advisers. Combining the human touch of an experienced financial adviser with the logic, fee transparency, methodology and accessibility offered by robo-adviser platforms can be a powerful combination for an adviser’s practise model.” 

Deciding on which route to take, either personal advice or robo-advice, will depend on your needs and goals. However, no matter how sophisticated robo-advice becomes, remember that it will only ever be able to offer limited advice based on the data you input.

Image source: By Photogree.eu/Shutterstock.com

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