So everybody is talking about robo-advisors…
As with any new cool technology, there seems to be many questions or misconceptions around it. Robo-advisors are the future, and therefore it is essential to understand what’s real and what’s just a myth before you decide to build one or use a robo-advisor for your investment needs.
Here are the top seven myths of robo-advisors you need to know.
Myth #1: Robo-advisors are the same
They may have similar characteristics such as lower fees, automated transactions, no or low minimum balances and easy account set-up, but robo-advisors differ greatly in many other ways:
- Types of available investments – such as ETFs, indexes, stocks, gold
- Fees or costs charged on your investments
- Access or non-access to investment advisors
- Minimum required initial investment amount ($1 or in the thousands)
- Add-on services such as rebalancing or tax loss harvesting
- Investment strategy
- User interface
With regard to investment strategy, each robo-advisor tends to have proprietary algorithms that utilize different portfolio optimization techniques. Most use variants of Modern Portfolio Theory (MPT), bootstrapping, Monte Carlo with some perturbations, Meucci’s or Bayesian techniques, Black-Litterman model and plenty more.
Figure 1 also shows the distribution of portfolio construction methodologies used by robo-advisors.
Figure 1: Robo-advisors and portfolio construction
(Source: Which algorithms do robo-advisors use?)
Overall, how a robo-advisor is constructed and its functions boils down to the company’s preferred investment strategy. As such, not all robo-advisors are equal. Taking some effort to find out the nuances behind a robo-advisor’s capabilities will help you understand these apps’ different outcomes. This is important when finding the best fit.
Myth #2: Robo-advisors only offer one-size-fits-all portfolios
Robo-advisors tailor portfolios according to the user’s goal or risk assessment. The assessment asks questions on a few factors: the time horizon, risk tolerance and amount invested, which quickly but sufficiently frames the user’s needs and financial goals. A mix of investment instruments from the robo-advisor’s investment universe will be selected as part of the constructed portfolio. A moderate risk investor looking to save for a house in the next five years will likely have a very different asset allocation (i.e, investments mix) compared to a low-risk investor looking to save for retirement in 25 years.
The level of personalization also would vary according to the number of risk bands that a robo-advisor provides. Similar risk levels and goals may result in similar portfolios. Still, such circumstances are arguably inevitable as too many permutations may hinder automation or make it too complex for a robo-advisor. This is also one advantage that human wealth management advisors have over robo-advisors – the level of understanding and personalization of a portfolio.
Other than personalizing portfolios according to goals and risks, certain robo-advisors also provide themed, sector, or idea portfolios for their customers. This is a different kind of personalization that may appeal to customers who prefer investing in things they are more familiar with, or enjoy spotting global trends or growth opportunities. Examples of themes in themed portfolios include shale gas, global recycling, online gaming, environmental social and corporate governance (ESG) and even, a “fight fat” portfolio (investing in multiple weight loss companies).
See how financial giants have built their robo-advisors and the kind of portfolios here: 8 Big Players in the World of Digital Wealth
Myth #3: Robo-advisors are only for young people
Not at all!
Robo-advisors are a convenient tool for anyone who wants help growing their money. Whether you’re a Millennial, a baby boomer, or part of Generation X, Y or Z, robo-advisors can help you kickstart your investment journey – at any age.
However, we do not deny that Millennials and the generations after them could be a financial jackpot, especially for Registered Investment Advisors who seek to relate to and engage a new generation of clients.
Find out why this is so: Millennials: The Financial Jackpot for Financial Advisors.
Myth #4: I have to choose between a robo-advisor or a human
Since both advisors provide different services, they are not mutually exclusive or even exist as competitors. Having one may not and does not need to stop you from engaging another. Consumers should think of both human and robo advisors as tools to achieve the same end goal of discovering their financial needs and to achieve their financial goals. They could also be targeting different segments: robo-advisors appeal to those with a passive investment strategy or with a lower amount of money invested, while human wealth management advisors are preferred by those who invest more aggressively or have a higher amount of money that they want to put in.
The means to the end may differ – robo-advisors take on more of a passive investment strategy and commonly have lower returns, compared to human advisors. They also cost less than human advisors (human advisors receive 2-3% commissions, compared to less than 1% for robo-advisors). Humans could also be more active in understanding your needs, tailoring your products and monitoring the returns. The higher level of involvement and personalization is also what drives up cost and requires financial institutions to be more selective with whose portfolios they manage.
As such, a person may switch between robo-advisors and human advisors or even have both as part of a holistic investment strategy depending on their financial needs.
Many investment professionals use robo-advising technology as part of their practice — and it works very well for their clients. Research indicates that many investors prefer a hybrid approach and that most clients expect their advisors to use technology to enhance their offerings.
Myth #5: Robo-advisors are expensive
Robo-advisors usually charge a platform fee that covers transaction and custody fees. On top of that, the underlying financial products include some management fees that are typically collected by the fund manager, not by the robo-advisor. You would pay these same management fees if you were to invest yourself anyway. However, fees can go lower if assets under management are high. Some robo-advisors even remove any platform fee for some of their portfolios, typically those that are low risk and power-saving to attract assets and work on converting them into fee-bearing investment portfolios.
Typically, robo-advisors charge a platform fee of 0.5 to 1% per annum, which is inexpensive given that it covers all trading and custody costs. If you were to use the services of a traditional advisor, you would be likely to pay at least 1% per annum, unless you belong to the high-net-worth and ultra-high-net-worth segments.
Myth #6: Robo-advisors are not smart and agile enough to weather market volatility
You may read that robo-advisors are not smart or agile enough to handle volatility like a Covid-19 crisis. In reality, it is often the contrary. A well-built robo-advisor buys without emotion when markets go down and trim when it goes up. On the other hand, you and your human advisor may base their trading decisions on emotions and do the opposite. Unless you are a financial genius, research shows that it is best to invest as passively as possible.
Myth 7: Robo-advisors are for those who can invest big
As we have noted before, you don’t need a high investment amount to invest in a robo-advisor. Robo-advisors are primarily for those who don’t have enough money or the time to do financial planning and investments. If you have a lot of money, you can get your own human advisor, which will often cost you more but may not provide you with the results you want. If you have more important things to do than to create and manage portfolios, you are better off with a robo-advisor that comes with a portfolio builder that does the job for you. It will work on investing and rebalancing your portfolios against fluctuations of the financial markets.
Robo-advisors can often do fractional units of mutual funds or fractional shares of ETFs, which allows them to invest very small amounts. Apps like Betterment in the US do not have any account minimum, for instance.
The wealth-as-a-service partners
If you want to harness the power of robo-advisors for your financial institution and are ready to build your own, we could be the WealthTech partner you need.
At Bambu, we understand the power of technology and how to build it in a way that works for all types of financial institutions.
Having built white-label robo-advisor solutions for 18 clients (including leading financial institutions like Franklin Templeton, HSBC and Standard Chartered), we are confident of building a robo-advisor solution tailored to your needs.
Bambu’s founders bring decades of experience in finance and technology. Bambu also has teams in various functions that contribute to building a great robo-advisor: think, UI/UX, AI, R&D and investment, who bring domain knowledge, technical expertise and user-friendly design to all our robo-advisory solutions. As such, Bambu has delivered engaging experiences, and been able to predict financial behaviour and formulate portfolios.
Speak to us at firstname.lastname@example.org to find out how we can find the right robo-advisory solution fitted for your business and customer’s needs.
Behind every robo-advisor is a team or a set of investment professionals who will provide and guide the investment methodology. After all,
“Robots capable of manufacturing robots do not exist. That would be the philosopher’s stone, the squaring of the circle.”
―Ernst Junger, “The Glass Bees”