What are robo-advisors and what should I know?

The threat of robots to humanity has been well-documented throughout modern history – in science-fiction at least. As the story usually goes, robots are built and programmed by humans to complete tasks quicker and more effectively. They then develop conscience, form an army and conspire to take over the world using their superior strength and intelligence. It’s a cliché of a storyline that is unlikely to play out in reality.

But presently, there is a breed of robot out there that some are saying is posing a threat, although not to humanity. They’re supposedly threatening financial advisors.

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, should financial advisors and wealth managers be fearing for their jobs? Not really – people will always need somebody with a human touch. But it is worth knowing about robo-advisors and what they offer.

What are robo-advisors?

Robo-advice burst onto the scene around two years ago in the US but has since spread around the world.

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.

Just to give you an idea of how powerful robo-advisors are becoming, market leader WealthFront is already managing over $US2 billion worth of customer assets – without ever having met and shaken hands with a single client.

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According to a Goldman Sachs report, robo-advice is attracting HENRY (High Earning, Not Rich Yet) clients with their lower fees.

But it’s not just the wannabe rich that are interested in their services.

Capgemini and RBC Wealth Management World Wealth Report found that 48.6 percent of high net wealth individuals around the world would consider letting a robo-advisor manage some portion of their wealth. In Australia’s region, the Asia-Pacific (excluding Japan), this rate was 76.3 percent – the highest of all the regions.

Pros and cons

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

Pros

  • 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 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

  • Less options: Many won’t offer many other advice services that are offered by a financial planner. For example estate planning, tax planning and a broader range of investment options.
  • Lack of in-depth insight: It can’t foresee potential risks on the horizon (e.g. China, housing bubble, RBA rate changes).
  • 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?

With NAB’s recent launch of Prosper, there is arguably a bigger push for other financial institutions in Australia to launch their own automated advice services. Thus, we could see more forms of this robo-advice in this country.

So are robo-advisors a threat to everyday financial planners/advisors?  Well, according to NAB, their digital advice platform Proper merely aims to reach out to the 80 percent of Australians who don’t already have a financial adviser and do not need or want complex financial advice. So there should still be plenty of face-to-face financial planning opportunities.

Also 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 practice model.” 

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. It may always be better to speak to a (human) professional who can take into account your whole scenario.

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