Will robo-advisers change the game?

Coming this fall to a theatre near you: Rise of the Robo-Adviser. If you haven’t heard the term before, “robo-advisers” are firms that handle investments using computer algorithms rather than human portfolio managers. Like most financial innovations, this one originated south of the border, but Canadian start-ups including Wealthsimple, Nest Wealth and WealthBar are rolling out new online offerings this year.

Each firm has its own unique features, but the general idea is similar. They start by determining your goals, risk tolerance and time horizon, and you’re matched with a suitable ETF portfolio. The computers look after the rest: all the trades are made for you, the portfolio is rebalanced when it strays from its targets, and in some cases you even get tax-loss harvesting to reduce capital gains taxes.

The main appeal, of course, is low cost. The pricing models for the new Canadian firms were still not clear at press time, but expect the cost to be in the neighborhood of just 0.5%, which includes all trading commissions but not necessarily the management fees on the underlying ETFs. (Some will charge a flat fee instead of a percentage of assets when portfolios grow larger.)

I’ve been an advocate of do-it-yourself investing with ETFs for many years, so I’m an enthusiastic supporter of automated index portfolios. But as a newly minted investment adviser who works with both do-it-yourself and full-service clients, I’ve spent time on both sides of the fence. Here’s my take on the rise of the robots.

Welcome to the machine. A distressing number of Canadians are paying 2.5% for an “adviser” who does little more than plunk their money in underperforming mutual funds. For these folks, the robo-adviser is a no-brainer.

Small investors have few good options in this country. Advisers who provide unbiased advice for a reasonable fee are rare, and they typically have minimum account sizes of at least $100,000, and often much more. That leaves smaller investors with the choice of managing on their own—which most aren’t equipped to do—or working with commissioned salespeople.

The robo-adviser model solves this problem, because minimums are low (sometimes zero) and you get low-cost ETFs rather than funds with high fees and soul-destroying deferred sales charges.

The online model is also ideal for investors who need only basic advice. Most robo-advisers have promised to offer personalized service by phone, though it’s not clear what level of service clients should expect. You’re unlikely to get the same attention you’d get from a full-service adviser, but many people don’t need that. If you simply need help deciding whether to use an RRSP or TFSA, or to set a goal for education savings, paying an adviser or financial planner may not be good value.

I also think robo-advisers will be a complement to planners who are not licensed to give investment advice or manage your portfolio. Online services might allow these planners to outsource that job.

When a human can help. Ultimately the decision between DIY, online service or human adviser comes down to how much you’re paying, what you’re getting for that fee, and whether you consider that good value. That will vary among individuals.

Robo-advisers have accomplished something remarkable: they have made low-cost, diversified ETF portfolios available to just about anyone. You no longer need to build one from scratch or hire a licensed adviser to do it for you. But there’s more to financial success than building a good portfolio. Many investors need ongoing planning services and—perhaps most important—someone to help them stay disciplined.

Over the years I’ve come to appreciate just how much bad behaviour can devastate investment returns. I still see people sitting on huge sums of cash after bailing out of the markets during the financial crisis of 2008–09. Many of those who stayed invested did so primarily because they worked with an adviser who helped them stick to a long-term plan. I believe robo-advisers can be helpful here, since the algorithms rebalance automatically—but only if the investor doesn’t click the panic button. The rise of the robo-advisers has coincided with one of the great bull markets of the century: the real test will come when we next experience a 20% or 30% drop in the stock market and online investors get jittery.

There is one more benefit to the rise of robo-advisers that can’t be ignored: it will force human advisers to get better at what they do. Now it’s not enough for an adviser to say, “I can give you access to a low-cost, diversified ETF portfolio with regular rebalancing,” because online services can provide the same thing at much lower cost. To justify their fees, advisers will need to improve the level of personalized planning services they deliver. In that sense, the new competition will be good for all investors.

Dan Bortolotti is an investment adviser with PWL Capital in Toronto. His Canadian Couch Potato blog can be found here.