As more and more people are becoming interested in online financial advisors (aka ‘robo-advisors’), we thought it would be helpful to dispel some of the myths around robo-advisors and what they’re all about.
Simply put, a robo-advisor is an online financial advisor – a web-based service that assesses your preferences and provides investment recommendations. Here are some of the more common misconceptions we come across in our business.
Misconception #1 – Robo-advisors cost about the same as traditional advisors
One of the key advantages of choosing a robo-advisor over a traditional human advisor is the cost savings. Using a robo-advisor is significantly cheaper than a traditional human financial advisor, for two main reasons:
- Robo portfolios are constructed using low-cost ETFs. ETFs are similar to mutual funds in that they provide excellent diversification, but they are not one and the same. Rather than trying to beat the market by actively selecting individual securities (i.e. stock, bonds, and other financial instruments), ETFs are designed to track a given index. This reduces the management fees paid to the fund manager (the largest part of the management expense ratio, or MER, in the industry), which can significantly impact performance over the long term.
- Robo-advisors automate and streamline administrative functions that traditional advisors (mostly) still do manually. This allows them to charge lower fees (in our case, around 0.50% or less).
Lower management fees, coupled with lower MERs on the underlying funds, makes investing with an online platform very attractive compared to the traditional model.
Misconception #2 – Robo-advisors are inferior because they lack human connection
But wait – “Low-cost? Automated? Streamlined?” – not exactly the stuff of warm fuzzies, right? Don’t you need a human being to make you feel comfortable with investing decisions?
Money is intensely personal. It can be uncomfortable to talk about. In fact, many people would sooner talk about death, or their own marital problems than disclose particulars about their finances. How many people put off investing or avoid dealing with their finances altogether, because they don’t feel comfortable talking about it, or are afraid of asking ‘stupid’ questions?
So I would argue that what some perceive as a weakness of digital platforms is also a strength; the beauty of robo-advisors is that you can approach the process of investing at your own pace, on your own time, from the comfort of your own home (and without any pressure from a sales rep).
Here in BC, you can visit a doctor via video conference. Imagine that! No time wasted in a crowded waiting room full of sick people. The same goes for online financial advisors: while there is a tradeoff in terms of human interaction, the upside is greater efficiency, privacy, and convenience.
Misconception #3 – Robo-advisors don’t provide personalized service
A concession here: yes, if you absolutely need to meet your financial advisor face to face, then a robo-advisor is probably not for you. When it comes to personalized service, human beats a robot every time, right? An online platform can’t meet you in person, take you golfing, or invite you to an annual client appreciation party.
A better question might be: are Canadian investors currently getting the personalized service they need? There’s this assumption that every financial advisor out there is providing this incredible level of service, but is that really the case? When 73% of women say that they are “unhappy” with the financial services industry, I think it’s fair to say that the ‘personalized service’ is somewhat lacking in the existing model.
Now the idea here is not to trash human advisors, many of whom provide significant value to their clients. But it’s getting more and more expensive for traditional banks and investment companies to run their businesses. Corporate offices and branches and investment reps are expensive. And because there are only so many hours in the day, from a business perspective, it makes sense to focus on the clients with the most money.
So if you, as an investor, have a moderate-sized account, you can choose to be a low-priority client of a top-notch firm, or a high-priority client of a less experienced advisor at an earlier stage of their career. Neither being an ideal option. Robo-advisors take a much more democratic approach – every account, regardless of size, has a portfolio designed by a highly qualified portfolio manager that is automatically rebalanced whenever it drifts too far from the target allocation.
And consider this: if you visit the website of any of the leading robo-advisors in Canada or the US, you’ll notice that many if not most provide live chat support, as well as phone numbers and email forms. How many human advisors do you know that offer live chat while you’re visiting their website?
Misconception #4 – Robo advisors are just a fad; they’re not here to stay.
It’s easy to think that, because it moves at such a glacial pace, the financial industry will always be what it’s always been. But the same could have been said for any industry that has been disrupted in recent years. Look at mass media, for example. Who would have thought that the leading print and news publications would struggle with readership and relevance (or revenues for that matter). The truth is, people never needed newspapers; they needed news. And nobody needs financial services firms, but they do need financial services. Robo-advisors are well-positioned to fill in service gaps and become permanent fixtures in the Canadian marketplace.
Misconception #5 – Robo-advisors are only for millennials or people with little money to invest
All this talk of technology and disruption makes it sounds like robo-advisors are only geared toward the tech-savvy (or those who can’t afford a human advisor). And while Millennials have been the earliest adopters of new online investment services, they are far from the only clientele.
For example, in the first quarter of 2016, popular US robo-advisor Betterment launched ‘Betterment for Business’ – a platform designed for company-sponsored retirement plans, or 401(k), similar to group RRSPs in Canada.
By simply looking to the US, where adoption of online financial advisory platforms is more widespread than in Canada, you can see that robo-advisory firms are thriving. Our prediction is that the ‘Uber-izing’ of the industry (i.e. making it available on demand, from whatever device you are using) will continue until a new equilibrium is reached.
Continue reading: 10 Common Misconceptions about Robo-Advisors (Part 2)