With the meteoric rise of robo-advisors in the wealth management field, it is unavoidable for advisors to feel intimidated, especially when facing a generational shift in assets to a younger and more technologically advanced generation. Perhaps the machines are doing some things right that attract so many new users and continue to be a compelling alternative to human advisors. So why not take a proactive step here by learning about how they operate and implementing good practices?
Robo-advisors are wealth management services that use computer algorithms to build and manage investment portfolios. These automated advisors bring a lot of benefits to the table, and one of the key advantages is the low management fees. They charge lower fees than conventional financial advisors at around 0.25% to 0.5% of investors’ assets under management (AUM). Besides the appealing fees, robo-advisors also provide investors with the convenience of opening an account at any time or putting money in to invest starting at any amount.
Robo-advisors offer a wide range of common services such as automated investing, automatic rebalancing, tax-loss harvesting, personalized financial planning and goal-based accounts. They are a great option for investors who want a simple way to grow their wealth or if they want to “set it and forget it”, and be passive in some part of their investments.
Since their debut in 2008, robo-advisors have risen to prominence among the younger generations, managing $460 billion in assets in 2020, an increase of 30% compared to 2009. The industry is anticipated to expand even further in the future, with some analysts predicting it will become a $1.2 trillion industry by the year 2024. However, experts claim that machines can never entirely replace human advisors in the future. Conversation engagement and the level of personalization when it comes to managing more complex wealth portfolios are just some of the elements that are irreplaceable. That said, wealth managers always have room for improvement when it comes to providing investors with the best advice and customer service.
Proactive communication is the foundation of a strong advisor and client relationship. However, robo-advisors’ biggest disadvantage is the lack of interaction with their investors. Even though the whole mechanism of robo-advisors is designed and overseen by humans, it is difficult to verbally communicate with robots if the investors go through any changes in their financial plans. According to Meg Bartelt, certified financial planner of Flow Financial Planning, they aren't as great at helping you and your family diagnose your personal financial problems and opportunities for improvement.
“Where a human financial advisor really thrives is addressing the other 90% of your financial life,” she says. “The big questions like how to buy a house, a car, quit your job and start your own business, or have a baby in the next five or 10 years.”, Bartelt says.
Considering this, advisors need to step up their communication game by initiating and engaging in conversations with their clients from time to time. This is a trust business, and what says trustworthy more than being available to clients through thick and thin?
Investors are dealing with market volatility, increasing inflation, interest rates and a high risk of recession, this is a perfect time for advisors to reach out and reassure their clients. “People want to check in, so don’t wait for them to call you”, says Jackie Porter, president and founder of Team Jackie Porter with Carte Wealth Management.
One of the most valuable features of robo-advisors is the ability to meet every client’s needs, from the required amount to start investing, to risk tolerance completely seamlessly. This is because robots use algorithms to tailor investment portfolios to each individual investor, and with the help of technology, it is highly efficient to come up with a portfolio after just a few short questionnaires.
At the same time, advisors may not be using algorithms to customize portfolios, but they should always strive to act in their client's best interests. Each client has a different set of goals and values when investing, and catering your services to help them meet those goals is one of the strongest drivers of trust.
In fact, one of the top considerations for wealth managers is to adhere to compliance and regulatory requirements when collecting clients’ data. Investors need to be comfortable sharing large volumes of information and trust that their wealth managers will only use it to act in their best interests. This level of personalization and dedication cannot be acquired by machines.
The takeaway lesson here? Find ways to respect fiduciary standards while making your client feel like you're building them a custom solution.
While it’s hard to compete with robo-advisors’ pricing rate at roughly 0.5% of AUM, transparency in how the services are priced will encourage investors to opt for a more conventional way of investing.
As a matter of fact, one of the key megatrends among investors transitioning into this new era of wealth management is the expectation for transparency regarding pricing structures. On top of that, this is also pressured by regulators across jurisdictions, as they are adopting more fiduciary rules requiring more fee transparency and scrutiny. Even if lower fees are not the top priority for some investors when choosing a provider, some of the richest clients are still disturbed about fee structures. According to the Wealth and Asset Management 4.0 report, only about a third out of every 10 investors understand how their wealth advisors are compensated.
“I’m going to look for transparency. The younger customers—I shouldn’t say millennials, because they’ve gotten to their 40s—now want to understand what exactly happens behind the scenes for them to trust that platform,” says Vinod Raman, VP and Director of Product and Operating Unit at Stash.
Perhaps the biggest strength of robo-advisors is how easy they make it to embark on an investment journey. All investors have to do is sign up, fill in a short survey; and that's it, they can start putting money in to invest in as fast as 15 minutes. Needless to say, it provides clients with ultimate convenience and accessibility.
This is the point where legacy systems are dragging wealth management firms behind. When we interviewed Gillian Kunza, CEO of Designed Securities, she told us, “When we’ve talked with other advisors, we know that with other systems, an account can take upwards of two weeks to open”. The gap between 15 minutes and 2 weeks is definitely not setting firms up for success when attracting and retaining new clients. On top of that, having to key in repetitive information increases the risk of human error or missing information. This can lead to more time and money wasted. In some cases, the cost of onboarding a new client could be as high as $25,000. (According to Forrester’s research).
Fortunately, wealth management firms can now close the gap by digitizing their whole onboarding process with the help of technology. As a matter of fact, Mako Fintech makes it so that advisors can now open an account at a carrying broker in just only 15-20 minutes.
“Work with them, not against them” is probably the best motto for wealth managers in this digital age. The star of the show here are the clients, and offering them the best service possible, with the help of technology, is something that financial advisors should always strive for.
Using data gathered from AI tools, it is now possible to obtain a better quantitative analysis of how products and services are performing in terms of generating revenue, reducing loss, improving customer service and mitigating risk. Given the coming changes and the need to adjust products to suit the next generation of clients, these insights will be invaluable for the wealth management industry.
“As the demographics of the wealth management industry evolve, changes to longstanding practices are being made. Savvy wealth managers will adopt the use of AI-augmented tools to free their time from mundane tasks and enable them to solve more critical and complex problems – which is where their real competitive advantage lies,” says Monica Hovsepian, Global Industry Strategist at OpenText.
At the end of the day, it’s totally up to investors to choose their suitable provider, but closing the gap between conventional financial advisors and robo-advisors will definitely help opting for human advisors a bit more apparent. Technology is rapidly advancing and will continue to do so in the future. It’s now high time for providers to embark on the digitization journey and transform their businesses, all for the better.
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Featured Image: Adobe Stock /heavypong
So in my view an appropriately diversified portfolio should have enough exposure to different asset classes, that its able to withstand a wide range of market disruptions. Usually, it’s some kind of negative or positive event… they’ll affect different asset classes differently. So by having your eggs in different baskets you’ll be well insulated from major risk. For example, there’s some kind of change in the housing market… both by having some exposure to it, you won’t miss out on the opportunity to make money. But if it’s something negative, you’re also not going to lose all your money if all of it were in the housing market for example. So at a high level, a properly diversified portfolio should grow in a growing market and yet not be at risk of major losses in a declining market.
You asked also about an efficiently diversified portfolio, and I would say that that’s a portfolio that achieves those goals with a minimum of different positions. There’s a lot of good reasons to have fewer positions in your portfolio. Being less complex means a portfolio is easier to rebalance and administer. Every time part of your portfolio goes up or down, you're going to need to rebalance it a little to make sure that it stays with the right allocations and the fewer positions you have, the easier it is to do that..the less trading fees you incur doing that.
There is a tradeoff between being completely diversified and being efficiently diversified. If you were completely diversified then you’d have a proportional segment of absolutely everything you could invest in under the sun, like shares of palm oil futures or something like that. I don’t think everyone should have palm oil futures in their portfolio but I’m not a wealth manager. I think it comes down to your portfolio and how large it is (probably the Canada Pension Plan has a proportion of palm oil futures in it). You’re going to have to talk to your advisor and choose a degree of complexity that’s right for your portfolio.
CN: Let’s just take a step back - what does a typical portfolio look like and has that changed over time?
RB: Yeah, so I'm not entirely sure what a typical portfolio looks like these days because it's actually changed quite a lot over time. I think common wisdom used to be that the classic balanced portfolio was 60% public stocks and 40% bonds. These days that's ancient history. Most would say that the bond allocation should be a lot lower these days in this age of unprecedented low-interest rates. These days it’s the stock portfolio that’s been driving a lot of the growth. I think a well-diversified portfolio in the modern era should absolutely include exposure to all kinds of alternative assets (that aren't even really that alternative but still kind of fall out of that traditional bucket). So you know I mentioned real estate, private companies, maybe for example commodities or other types of investments. So I think that there are a lot of things that you can invest in and your advisor can guide you on what’s appropriate for you.
CN: Yeah that makes a lot of sense. Talking about alternative investments, we’ve heard a lot this year about ESGs, impact investing, alternative investments… do you think there’s more of an appetite today for these types of investments than in the last ten years?
RB: Yeah that’s a topic that’s close to my heart having previously started an impact investment company. It’s definitely been a gigantic increase in interest. I think when I started my previous company we were speaking to large wealth managers and having them say “we’re barely getting a grip on early ideas.” Like not including gun manufacturers or tobacco companies, and now these same companies are launching impact portfolios and marketing this aggressively. So there’s definitely been a seat change, it’s a real industry, and there’s a lot of studies out there and data showing that ESG or impact investing can equal or outperform non-impact investments. So I think it’s a huge part of the market these days. That said, one of the things that’s driving it is people’s interest in it. I think that one of the stories of the investment industry has been the personalization of it. People’s portfolios are being tailored to their own needs and circumstances. Impact investing is definitely a piece of that. People are environmentalists, but an institution is not an environmentalist. It doesn’t live and breathe the impact on the environment the way an individual does. The person who is active in the David Suzuki Foundation for example is going to be active as an impact investor and it’s appropriate for them to be.
That’s a great question. I think there's a lot of advantages and you gain a lot with an automated platform. For me, it's a lot easier to manage. I have some of my money in one of these platforms and I barely think about it. It's being rebalanced all the time. The costs are much lower in terms of expense ratio for the same kind of rebalancing. Again you're missing a lot with that, but on just the mechanical portfolio rebalancing you're getting a great deal there. I would say that two other advantages are up-to-the-minute reporting, so you always have that login where you can see your position, see how your portfolio is doing historically. And finally, this is an advantage for me and anyone who doesn't love doing taxes, but typically they’ll take care of your tax forms for you, and end up with much simpler tax forms, so it kind of works out what your cost basis was and how much you have to report.
CN: So let's talk about the other side of the coin then...what are the risks of not having a seasoned professional managing your money?
RB: I wouldn’t exactly phrase the question that way. You know it's more what’s the benefits of having a real wealth manager? Some of the clients of robo advisory firms may not even be aware that they're missing out. A wealth manager isn't just balancing your stocks and bonds, that's kind of the very lowest mechanical level of what you get out of the wealth manager. Really they're your advisor on your life. Intimately intertwined with you because you're thinking about retirement planning, on planning for college for your kids, when is the right time to buy a house, and when should you get life insurance, for example. An advisor can help you with all of those decisions and they can connect you with service providers like a mortgage broker when you may be in need of one. So I think that you get a lot of value out of having one of these advisers, particularly when you get to a stage in life when these kinds of services are more about the long-term and your life circumstances are far more critical.
CN: There are clearly pros and cons and two sides of the story depending on who you're asking. Like you said, what stage of their life they’re in ...but do you think the platforms that we’re seeing emerging like to Qtrade, Wealthsimple, and all the rest will ever become status quo?
RB: Yeah, I do actually. I think that similarly to how you know we’re using online platforms to automate everything for us (I can’t think of the last time I used to travel for example), everything you’re going to be trying to do with your money is going to be automated, and it’s going to be appropriate to be handled by one of these one of these platforms. In particular, for most people at an early stage in their lives that have few assets to manage, not a lot of complexity, not a very extended personal family circumstance, it’s gonna make a lot of sense to have a low fee robo worry about it. But at some point their life circumstances are going to get more complex and you’re gonna get married, or maybe you’re not, or you may have other objectives that you may want some advice on and at that point it may make sense to either supplement the robo advisory portion of your portfolio, or graduate to a more holistic wealth management view.
CN: Thank you so much Raph, these answers were great. It’s always insightful chatting with you so thanks for sharing those answers with us today.
RB: It’s my pleasure.