Robo-Advisory – The Future?

Robo-Advisory is on the rise! A recent forecast expects Robo-Advisors to manage assets upwards of US $2 trillion by 2020. Robo-Advisors sprouted in 2007-08 near the financial crisis but have only jumped into prominence in 2010 after the launch of Betterment LLC, which in 2015 was the largest independent Robo-Advisory firm.

Looking at the success of the new Robo-Advisors traditional firms such as Vanguard and Charles Schwab &Co. launched their Robo-Advisory services. Vanguard currently leads the market with its Robo-Advisory arm having AUM (Assets Under Management) to the tune of US$ 101 billion.

Robo-Advisors explained simply: digital robots that provide financial advice.

In essence, Robo-Advisors will do all your investments for you based on your shared goals. Some of the first and largest Robo-Advisors are based in the U.S., hence most of the data about how Robo-Advisors operate comes in from there.

Almost all Robo-Advisory services offer a platform where you as a user are required to answer a detailed questionnaire to give the algorithm an understanding of your financial position and needs. Questions about your current income, expected income growth, your propensity to save, your risk tolerance and your retirement goals are all commonly asked. Note that the more detailed the questionnaire the more the Robo-Advisor will be able to learn about you and more tailored the service will be. Most services take these responses and provide you with an investment plan. Once you approve the suggested plan, the algorithm will make the investments for you.

Robo-Advisors offer a slew of benefits as compared to a traditional advisor and hence have been able to take the market by storm.

Accessibility: Financial advisory has traditionally been seen as a service for the rich. Primarily because most traditional financial advisors have a large minimum investment requirement (the minimum requirement to open an account with SEBI registered portfolio manager is Rs. 25 Lakhs). Robo-Advisors on the hand have a very small to no minimum deposit requirement; this makes it accessible for smaller ticket size investors.

Low Fee: The fee charged by Robo-Advisors is on average lower than the fee charged by a traditional advisor (difference being 0.1 – 0.5% of AUM vs 1%-2% of AUM). Actual difference in cost is on account of 2 main reasons:

  • Very low to no minimum deposit requirement.
  • Robo-Advisors enjoy economies of scale, since one algorithm is used by all the users.  

Passive Investment Approach: Robo-Advisors do everything for their client at the click of a button. From portfolio rebalancing to tax-loss harvesting can be done with little to no human intervention. Also, a majority of Robo-Advisors invest in ETFs which furthers with the theme of a passive investment approach.

It is important to note, that not all Robo-Advisors are just robo’s advising. Some of these services offer some human intervention either bundled or at an additional cost. Betterment, for example, offers “expert” services, within which they have offerings like a one-time call with a CFP (Certified Financial Planner) at a fixed charge or “Betterment Premium” which give you unlimited access to a team of CFPs with whom you can interact over e-mail and phone.

The debate that exists is one as to whether Robo-Advisors will be able to completely replace the traditional investment advisory industry. The short answer is no.

The most common argument for traditional financial advisors has been that they can offer their investors with real support during bear markets and prevent them from acting irrationally. I agree. If I am an uninformed investor and I see my holdings take a significant hit, I too will panic. Having a voice at the end of the phone line reassuring me will always be better than interacting with an app. But will that one event swing me entirely in favour of hiring a traditional financial planner? Not really.

Not only that, very recently the South Korean market has been going through a bear phase, between August 2018 and August 2019, the Korean index KOSPI (Korea Composite Stock Price Index) (Korea’s benchmark index) lost 15.29% and the tech-heavy index KOSDAQ (Korean Security Dealers Automated Quotations) lost 25.27%. Risk-seeking, risk-neutral and risk-averse Robo-Advisors, on the other hand, returned 3.08%, 0.82% and -1.64% respectively. Highlighting that even during bear-markets Robo-Advisors can provide good returns since they are not influenced by emotions and carry diversified portfolios.

For me, the more plausible future is one where traditional financial planners exist along with their robot counterparts. A sustainable model which has started to come about is a hybrid model, where a traditional firm offers both services. By offering Robo-Advisory on their platform they capture a market they had previously ignored completely (i.e. catering to those who couldn’t meet the minimum investment criteria).

Traditional firms can, therefore, continue to offer the full boat of personalized services for the bigger ticket size clients, and focus their human capital on higher revenue-generating activities like estate planning and trust creation. Further, a lot of algorithm development firms such as Betterment offer Robo-Advisory to smaller firms. The smaller firms can then rebrand the algorithm to put their logo and name on top and offer the same Robo-Advisory to their clients. A practice fast becoming popular in the U.S. and is likely to become popular in India soon. Traditional firms like Vanguard, is now a market leader in Robo-Advisory, with an AUM of U.S. $101 Billion, whereas Betterment, the oldest and largest independent Robo-Advisory firm has an AUM of U.S. $13.5 billion, further highlighting the investor’s preference of a hybrid model.

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