Can Robo Advisors Take Wealth Management to a New Level?

04.10.2021 | 7 min read

A white human-like robot touching a seethrough screen with algorithms

There’s no doubt that the advisory model in wealth management is changing. With the rise of FinTech and new AI solutions in the sector, investment advice is now more accessible than ever before. Traditionally, it involves the input of a number of experts in various fields - not only those skilled in giving investment advice, but also legal specialists, tax advisors and accountants. For this reason it has (until recently) been considered the domain of the rich. But robo advisors are rapidly disrupting wealth management. We decided to take a look at what they are and how they work.

What is a robo advisor?

Robo advisors are digital platforms that provide automated algorithm-driven investment and financial planning services. They usually collect information about a prospective client’s financial situation through the use of a simple survey and use automated portfolio management to make strategic investments. The first robo advisor was Betterment which launched in 2008 just before the start of the recession. At the time, the technology itself wasn’t new to the market, but only investment professionals had access to it. Betterment introduced a significant step change, as it meant that it essentially cut out the middleman in the wealth management process.

The types of services that robo advisors provide

The scope of services that robo advisors can offer is constantly growing. At present, portfolio management and asset allocation usually form the key offering and these are provided using ETFs - Exchange Traded Funds. For new investors, there are sometimes preset portfolios of stocks or ETFs which can be purchased at the click of a button.

Robo advisors are divided into simple and comprehensive. The former uses conventional profiling to come up with a suggested portfolio. They base their outcomes solely on the questionnaire that a user fills out, which determines their risk tolerance.

More comprehensive advisors go beyond the initial questionnaire to create a more detailed picture of the client’s risk appetite. The base data is still valuable in that it notifies the advisor of key information such as your actual net worth, your spending patterns and your current liabilities. But it also works to predict behaviour using AI algorithms which consistently learn as they are fed new information.

INDmoney is a good example of a robo advisor that uses machine-learning to provide users with highly personalized investment advice.

Robo advisors for tax loss harvesting

There are some robo advisors which offer further services, such as tax optimization strategies, and tax loss harvesting services for portfolios that are not tax-advantaged.

For the average investor, tax loss harvests can be tedious and difficult to perform, which is why robo advisors are increasingly being used for the process. They can create and manage personalized asset portfolios using ETFs. Robo advisors have algorithms in place based around set computational rules which means that when a realized gain is made, the system will sell a losing investment to counteract it but won’t repurchase the same security.

Wealthfront is one example of a robo advisor that offers tax-loss harvesting services. It is able to maintain the best possible risk-return allocation for your portfolio, without violating any set financial rules (such as those imposed by the Internal Revenue Service, IRS, in the States.)

Personal Capital also offers tax-loss harvesting, allocating assets where they’ll be less taxable, and choosing the most efficient investment vehicles to minimize taxes.

Robo advisors for retirement accounts

In addition to the above robo advisors offering tax optimization services, there are some which specialize further, such as those offering to manage client accounts on a consolidated basis and a few which specialize in retirement accounts.

Capital One Investing (formerly United Income) is a robo-advisor specifically created for retirees. When a user creates a full financial profile and invests using the platform, it runs millions of simulations to figure out whether they are on track to meet the goals that they’ve set for themselves (even if these goals change). Capital One attempts to outperform the market, rather than just matching it.

What are the key benefits of robo advisors?

Robo advisors bring a number of benefits to both individual users and to financial providers.

1. Lower costs

By eliminating the need for human labour and thus eliminating the need to pay salaries, robo advisors provide a cost-effective solution to wealth management. As Investopedia reports, most robo-advisors charge an annual flat fee of 0.2% to 0.5% of a client's total account balance. That compares with the typical rate of 1% to 2% charged by a human financial planner (and potentially more for commission-based accounts).

2. Accessibility for wider social groups

In the traditional model of wealth management, prospective clients had to have an investable wealth threshold of $100,000. In contrast, the minimum amount of assets required by a robo advisor is $5,000. Indeed, there are some that have no baseline at all. Millennials have been the first demographic to truly embrace the robo advisor trend.

3. Round the clock, remote access

The pandemic led to an increased pace of digitization across the banking sector, and it was a time in which robo advisors really came into their own. All that’s required to use them is a stable internet connection.

4. More efficient management of investments

In the traditional model, when a client wanted to execute a trade, they would have to physically meet with a financial planner. In contrast, the majority of robo advisors provide algorithm-based automated investment solutions. These automatically auto-rebalance the asset allocation of the client’s portfolio, without them needing to do anything at their end.

5. Increased transparency

Thanks to the digital interface of most robo advisors, investors can easily analyse their returns and see their progress towards the targets that they set for themselves. Robo advisors offer a clear, at-a-glance view of how each investment is likely to perform.

Are there any limitations of robo advisors?

Despite many benefits there are still some limitations to robo advisors which should be noted.

1. The lack of a human touch

There is definitely something to be said for the benefits of having a human financial advisor, who knows not only your investments and your financial history, but also your risk appetite and your personality. Human advisors are particularly useful to those who are less savvy when it comes to investments. Such investors might, for example, be put off by a single loss and decide to alter their portfolio as a result. Here, a traditional advisor could explain to them why this isn’t a good decision.

2. The inability to build a fully personalized portfolio

Because they don’t have a complete picture of every client or investor as a person, robo advisors are always that step away from a fully personalized service. They might not be able to screen out investments that stand against a prospective client’s belief, and don’t yet have the functionality to explain why a particular investment might be favourable to a given individual over another.

3. The inability to perform complex financial planning - e.g. retirement or estate planning

Robo advisors are not yet commonly used for more complex financial planning requirements such as estate management planning, retirement or tax planning (although, as mentioned above, some are beginning to make forays into these areas). While the technology exists to do this digitally, the process is still too complex to manage for the average investor - as it requires a certain in-depth understanding of the subject - and how to input the figures.

Examples of robo advisors for different types of investors

There are many different types of robo advisors on the market, each with its own offering. Here are just a few that we selected to illustrate the breadth of what clients can choose from.

Merrill Guided Investing: Contains a great onboarding video and useful education materials about investing and usage of the platform. A good option for those who are new to wealth management and haven’t used a robo advisor before.

E*TRADE Core Portfolios: Highly optimized for mobile usage, which makes on the go investment straightforward.

Wealthfront: Offers top UX and the ability for users to easily set investment goals for themselves.

M1 Finance: Offers low costs and is particularly well suited to more savvy investors.

Do robo advisors herald a new era of wealth management?

Robo advisors are certainly paving the way for a new approach to wealth management, but prospective investors need to carefully consider which type of robo platform is best suited to their needs.

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