What a robo-advisor can’t do

Do investors need traditional advisors anymore? Over the past few years there has been a rise in the use of online portfolio managers amongst affluent investors.1 These robo-advisors started out as automated online services that used risk tolerance questionnaires to determine a suitable investment solution for you. But these services have evolved from solely providing basic portfolio management, to now include access to a qualified advisor when needed. This shift should be a clue that traditional investment advisors are still relevant in portfolio management today.

The rise of the machines

Robo-advisors are becoming increasingly popular amongst affluent do-it-yourself investors who don’t necessarily have the time or interest to commit to educating themselves, and would like to delegate the task. They are also being used by investors who have an existing relationship with an advisor, but may be diversifying their portfolios between institutions. In fact, some advisors are even suggesting their clients try out robo-advisors with a portion of their portfolio.

One would think the rise in their usage would be attributed to technology-loving millennials. But that’s not the case. In fact, robo-advisors are being embraced by investors across all demographics. According to the report Wealthy Investors and Their Perceptions of Robo-Advisors, 64% of investors over the age of 61 who sought investment advice for the first time used a robo-advisor. 1

Proponents of these services argue that investors need minimal help from humans. They claim that robo-advisors can better manage their portfolio needs, and deliver index-equivalent performance at a lower cost than bank-offered mutual funds. The typical robo-advisor uses passive investment products, such as exchange-traded funds (ETFs) or index mutual funds, while some use a combination of ETFs and pooled funds. Pooled funds are mutual funds designed for high-net-worth investors. But is that really all there is to it?

When the tide turns

Robo-advisors may do a good job of maintaining a client’s portfolio, especially during periods of low volatility in the markets and over long periods of time, but what happens when the markets turn volatile? It would be interesting to see how clients of robo-advisors would deal with a market decline similar to what we saw back in 2008/2009, when equity markets dropped more than 30%. Would robo-advisors be able to keep their clients invested and help them avoid selling stock in a panic? Managing an investor’s behaviour and emotions is an integral part of the services an advisor can offer.

A more technical point to consider is whether the robo-advisor’s algorithms are right for the future. Will the assumptions that hold true today be valid in years to come? Or, are they adjusting the portfolios to be more in line with the current realities of inflation and growth, not to mention the likelihood of rising interest rates.

The whole enchilada

Firms like WealthBar, BMO SmartFolio and Questrade Portfolio IQ now offer mobile apps that allow you to monitor your investments even if you are not using their advisor services. But are simple risk-tolerance questionnaires, which serve as the core of the robo-advisor’s client discovery process, an adequate substitute for a one-on-one conversation?

Basic information such as age, goals and risk tolerance do not necessarily get to the heart of understanding the entirety of an investor’s financial needs and objectives. Nor do they consider how one’s investment portfolio works in the context of their complete financial situation. Investing is just one piece of the puzzle. People need to see the bigger picture, which includes a complete financial plan that addresses many issues in addition to investing.

The well-known robo-advisor site Wealthsimple has acknowledged this demand and offers some financial planning with an expert advisor in addition to their online investment services. But financial planning requires more than a couple of conversations over the phone with an advisor. It’s an interrelated process that involves delving into one’s financial situation that goes beyond their investments.

Traditional advisors can work with their clients to create customized plans that address their clients’ evolving needs, such as balancing multiple savings goals, creating an effective estate plan, and implementing tax-minimizing strategies. For example, consider a situation where your income might be higher than normal – perhaps you sold a property or received a severance package – and this put you into a higher tax bracket. A traditional advisor who knows of your circumstances can provide tax-minimizing strategies to reduce the impact of such an event, whereas a robo-advisor would not offer any kind of tax planning. It would continue to churn capital gains while systematically rebalancing your accounts, creating additional income.

Robo-advisors can be a helpful tool as much as any digital platform. They can certainly complement the services of a traditional advisor, but have some way to go before they can serve as a substitute for the more personal aspects of wealth management that a traditional advisor can offer.

Darin Yuzyk, T.E. Wealth, Calgary

1Investment Executive. (2017, January 12). Mass affluent investors in the US relying more and more on Robo-advisors. Retrieved from http://www.investmentexecutive.com/-/mass-affluent-investors-in-the-u-s-relying-more-and-more-on-robo-advisors

This article was published in T.E. Wealth’s Strategies newsletter, February 2017 edition. Read the full edition here.

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These articles are for general informational purposes only. Please obtain professional advice before taking any action based on this information. No endorsement or approval of any third parties or their advice, information, products or services should be implied by any references to third parties contained in any article. Trademarks cited in these articles are the respective properties of their owners.

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