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The new robo-advisors: same shizazz, different shirt?

October 17, 2014 by InvestingForMe

Over the past few months, a number of online companies have sprung up offering investors a new investing option when it comes to their savings. And the media has labeled these so-called new services robo-advisors.

 

But is it really all that new? Or is it simply the same old robo-service dressed up in new packaging?

Robo-advisors: how they work

Robo-advisors first began to appear in North America with the launch of WealthFront in 2008. Robo-advisors describe themselves as online, automated investment services and most give you a questionnaire so they can identify your investing experience, goals and investment risk tolerance. Then, from your answers, they determine your perfect investment mix (you know so much invested in bonds, so much in stocks, etc.) and create a customized investment portfolio (typically using individual exchange-traded funds).

Once the robo-advisors have created your personalized portfolio and your savings have been invested, with the help of their computers and customized software, the robo-advisors then monitor the market values of each investment type in your portfolio, and when the investments get out of whack (i.e., when some do really well and go up in value more than the others or when some don’t do so well and drop), the robo’s computers automatically kick in and sell a portion or all of your successful investments and buy more of the less successful investments. In other words, the robo-advisors automatically re-balance your investments back to your perfect investment mix. Sounds good so far, right?

Wait for it: here comes the same shirt …

Some of today’s robo-services also offer to throw in yet another added service – a human voice with their customized computer software service. Uh, that’s right. Turns out, some robo-advisors employ real-life investment professionals to help you with your investment decisions where you’ll have the ability to call and email them to benefit from their extensive experience and knowledge. And the new robo-advisors claim that this human touch factor makes their new investment service unique. Really?

 

Been there, done that …

Automated investing and rebalancing has been around for decades. It first appeared in the mid-1990s at banks and mutual fund companies. Just like with today’s robo-advisors, that old-new automated investing service was going to outperform and eventually replace traditional investment advisors. And, just like today’s new service, you completed a questionnaire, which generated a personalized investor profile (i.e., identifying your investing experience, goals and investment risk tolerance) and based on that profile your savings would be invested in 3 or 4 different portfolios – typically with descriptive names such as Conservative, Balanced, Aggressive, Income, etc.

And once every quarter, the investment company’s computers and customized software would automatically re-balance your investments back to their so-called perfect allocation – you know, selling a portion or all of your winning investments and buying more of your not so successful investments.

Will the new robo-advisors be any more successful this time round?

Who knows. But as Wikipedia correctly notes in its definition of robo-advisors, it’s not the automated service, technology and tools that are new, but it’s the distribution channel now available to them that’s different (i.e., they’re now website based):

The main difference is in distribution channel. Until recently, portfolio management was almost exclusively conducted through human advisors and sold in a bundle with other services. Now, consumers have direct access to portfolio management tools, in the same way that they obtained access to brokerage houses like Charles Schwab [discount brokers] and stock trading services with the advent of the Internet.

So, if this is true, that automated robo-advisors are not a new service, but instead they’re a new channel for investors to access investments, then what kind of investors are most likely to use today’s new robo-advisor service?

Investing: always about TRUST

Before any of us can speculate about the future success of robo-advisors, we first need to understand how the majority of Canadian investors think when it comes to their hard-earned savings and investing. And, if we want to understand what motivates us to select the investment channels that we do (that is, either a paid advisor, discount broker, bank account manager, or robo-advisor, etc.), you only need ask one simple question – who do investors trust most?

Different strokes for different folks

The answer is different for each of us.

I’m old enough to remember the time when working as an investment advisor at a full-service firm in the 1980s we were told by the media that our future as advisors was over because of a brand new investing service called discount brokers. And just like today’s media, the media back then gave a litany of reasons why no sane investor would keep paying a full-service broker’s high costs when they could simply move to a discount broker and do it themselves.

And with hindsight, the media back then, just like today’s media, got it partially right. Some investors did transfer their accounts to discount brokers and began to make their trades all by themselves. But they were, and still are today, the minority of investors. The majority of Canadian investors still prefer to work with a paid investment advisor or bank account manager when it comes to their investments because they want to feel their hard earned savings are in trusted, safe hands (whether with an individual advisor or with the company that the individual works for such as Royal Bank, CIBC, Investors Group, etc.). And they don’t mind paying the higher investment fees for that trust.

So, while it’ll probably remain true today that most investors are willing to pay the higher investment costs if they trust the advisor or the firm the advisor represents, you have to wonder who will use these so-called new robo-advisors. Will investors today trust them enough to use them?

The answer is both yes and no:

  • The answer is yes for those investors currently using a discount broker who are already comfortable with technology and going-it-alone. As long as they understand how robo-advisors operate, I think they will trust a portion of their savings to this new investment channel.
  • The answer is no, however, when it comes to those investors who buy high-cost mutual funds and use higher cost, paid advisors because the majority of Canadian investors like to know that a real person backed by a real company is handling their savings and investments.

Fact: Among Canadian retail investors, 83% work with a financial advisor and they hold 81% of their savings and investments in accounts with advisors. 

Robo-advisors: good when the going is good, but …

If history has anything to teach us about the future success of the new robo-advisors (even with their convenient easier distribution access), they may just go by the wayside as well as their predecessors for the same reason their popularity faded in that last go around in the 90s. Unfortunately this type of service is only appealing for investors when stock markets are rising (i.e., when the going is good!). When things go sour, however, as in a bear market, we see historically that investors tend to turn away from such services. Why? For two good reasons:

  1. The majority of investors understandably hate not having anyone to call and hold their hands when the market values of their investments are falling. And, while yes, a few robo-advisors do offer access to investment professionals, the access to these resources has yet to be tested in a declining stock market, when call volumes typically spike.
  2. The majority of investors understandably can’t stomach the automated service’s concept of re-balancing their investments in a stock market that’s dropping in value because re-balancing dictates selling your safest, most successful investments to buy more losing investments.

Conclusion

So, investing always has been and always will be about trust. And while new ideas and technologies will come and go, the take home message to the average Canadian investor is to decide what kind of investor you are – in good times and in bad – because most of us like to have someone out there holding our hands in some form or another.

That’s not only ok, it may be wise investing. Sometimes these so-called new services sound great when stock markets are good. (They’ll do everything automatically and save you the costs of the middleman!) But what about when the good times end? Are you going to be happy with no one to call? And are you going be happy when your more successful (sometimes safer) investments are sold by your robo-advisor to buy more of the investments that are hurting your portfolio? Well, these are the kind of important issues you need to consider when you play the investing game.

 

 

One Final Thought: I think the next chapter in the robo-advisor story will be written by the Discount Brokerage firms. Most of them have the capabilities, today, to create and offer their own robo-advisor services to clients. In the coming weeks and months, I'll be watching, with great interest, to see if the discount brokers shut the door on today's robo-advisors with their own robo-services offering.

 

 

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