If you’ve been paying attention to the world of personal finance on the interwebz, you’ve probably heard a thing or two about robo-advisors, which are, depending on your perspective, either the greatest thing since flush toilets or the actual literal spawn from Satan’s seed.
First, let’s take a look at what the hell a robo-advisor is, and then we’ll talk about whether they’re all that or not. Well, I’ll talk. You’ll do that thing where you listen, but with your eyes.
What’s a robo-advisor?
Ever since the days of Robocop there, man has dreamed of finally shirking off all of his work to robots, leaving him free to watch videos of cats on computers. At least, I’m assuming that’s how that movie went. I never actually saw it.
A robo-advisor isn’t even a robot. It’s a software algorithm that invests for you, based on a specific risk profile. If you tell it you like to regularly mount (NOT THAT KIND OF MOUNT, GEEZ) bulls just to get bucked off and possibly crushed a few seconds later, you’ll probably have a lot of stocks in your portfolio. And if you’re like me and charge your phone when it hits 60% “just in case”, you’ll probably not be a lot of fun in general. Oh, and you’ll own more bonds.
I’m not quite giving robo-advisors enough credit, but that’s pretty much it. They do other stuff like tax loss harvesting, rebalancing, and so on, all while charging investors a very small management fee, often between 0.10% and 0.50% of their assets.
The big thing is investors never see an actual live advisor. Everything is done automatically by the software, with very minimal human involvement. All the information is there for folks who want to look, but you’re still pretty much on your own.
The logic behind some of the portfolios is pretty interesting. They invest in stuff with a proven history of beating the markets, including equal weight indexes, small-cap stocks, and seeking out the lowest cost index funds. To be honest, I’d say many of the robo-advisor portfolios are better than those recommended by actual non-robot advisors.
Naturally, the folks who are huge finance nerds are very exited by the prospect of robo-advisors taking over and making everyone’s non-sexual dreams come true. They already manage their own portfolios, think it’s quite easy thank-you-very-much, and think everyone should cut costs as low as possible. Managing your own cash is ideal, but for the folks who can’t, a robo-advisor would work just as well for just a little more in costs.
But is that really something that’s going to happen? This is when I start to get a little skeptical.
Why do people hire advisors?
I used to own shares of Investors Group (IGM Financial on the TSX), even though I was thoroughly dissatisfied with the interview process, their sales tactics, and the high-fee mutual funds their advisors constantly push.
Why? Because to someone uneducated, Investors Group looks like the ticket. Look at their marketing if you don’t believe me. They know you’re scared, but don’t worry. Your local Investors Group consultant will wrap you up in a nice warm blanket that smells vaguely like lilacs. You pay very well for this, but the average person doesn’t know that.
It’s been a good business for years, but that’s about to change. In 2016, regulators will require mutual fund companies to disclose what the fund costs in dollar terms, not just percentage terms. This looks to be a pretty big deal for the average mutual fund investor. A 2.5% fee on $100,000 in assets doesn’t seem like much. But $2,500 in fees seems like a lot more, especially in a year when the market goes down.
Smart people are aware of this, and are positioning their business accordingly. Some advisors are really pushing wrap accounts, which put investors into low cost ETFs with a management fee of 0.5% to 1% of assets to manage it. Others are embracing a fee-only model, which ends up being a pretty good deal for folks with a lot of assets, and a lousy deal for somebody just starting out. It’s hard for someone with $10k in the bank to pay $1,000 or $1,500 for a complete financial plan. That’s not much for someone with $1 million in the bank, but it’s a prohibitive cost for a lot of people.
Which is why I think a hybrid model is the ticket.
For years, banks have been giving free financial planning advice to go with the mutual fund sales. People have issues with the poor quality of this advice sometimes — and rightfully so — but it’s essentially a loss leader to get the person in the door. They show up for a “free” financial planning session, and it gives a fully diversified financial services company a chance to sell them insurance, a mortgage, expensive mutual funds, and so on. Selling each of those products is a nice payday for an advisor. Selling them all easily justifies spending a few hours per year on financial planning.
Selling expensive mutual funds isn’t going to cut it any longer, but there will always be a call for the other stuff. And for many people, the option to talk over their problems with a knowledgable financial planner is very valuable.
And that’s the crux of why I think robo-advisors have a long way to go before they’ll dominate the market. Most people get value from the calm, reassuring voice sitting across the table telling them that market declines happen. Us finance nerds constantly forget just how clueless the average person is about this stuff. And remember, financial planning is about more than just investments.
There will always be a small minority of people who feel comfortable doing everything themselves. But the vast majority need reassurance, hand holding, and somebody seductively stroking their thigh. Which is why I liked Investors Group as a stock before the fee disclosure rules changed, and why I think there will always be a market for a regular financial advisor — no matter how they get paid.