The financial services industry is often known for innovation, although not all ideas gain traction in a crowded marketplace. The first robo-advice services were born out of the financial crisis in 2008, when US firms Betterment and Wealthfront launched the first automated advice services, which were touted as major disruptors to the financial services industry. However, given the struggle that robo-advice firms face to turn a profit from their activities, and significant flaws in the efficacy of a robo-advice process, some are beginning to question whether robo-advice has a long-term future.
The journey to obtaining robo-advice is an online experience. Depending on the robo-advice provider selected, the website will ask a series of questions relating to an individual’s appetite for investment risk, time horizon for investment and other key factors. By using a computer algorithm, an investment portfolio is then selected from a small range provided. These portfolios are usually invested in passive investments, such as Exchange Traded Funds, and some services provide rebalancing of the portfolio at regular intervals.
Given that most robo-advice services only use passive investments, that track a particular index or set of indices, there is little ability for a fund to outperform markets generally. This is where investors can miss out on potential returns offered by actively managed funds, where costs are higher, but performance can exceed the index return over time. Of course, actively managed funds can also underperform their target return, and this is where the value of advice can help select good performing funds, which are reviewed regularly.
Robo-advice services are also restricted, which means that they can only provide advice on products and funds from a severely limited range. This is in stark contrast to an independent, whole of market advice service, who can select the most appropriate solution and select funds from across the market.
As the decision-making process is automated, the investor has very limited control over the assets chosen by the algorithm used by the robo-advice service. Whilst some offer options to take into account ethical or socially responsible investments, there is little the user can do beyond this to tailor what is selected for their investment portfolio.
The advice service provided by a robo-advisor is very much hands-off. There is usually limited human interaction and the services lack the personal touch that face to face financial advice can provide. This is, in our opinion, the key flaw of robo-advice. The essence of the service that a human financial adviser can provide is that the advice given is tailored to each client’s specific needs and objectives.
Ensuring that investment decisions are suitable is a key component of effective investment planning, and this is where algorithms led by rudimentary questionnaires can leave significant gaps. A human adviser can really get to know and understand a client, considering elements such as their past knowledge and experience of investment markets and emotional reaction when talking about the potential for investment volatility. A holistic advice service can also consider wider financial planning considerations, such as making tax-efficient decisions to reduce current or future tax liabilities, and areas that clients often don’t immediately consider, such as protection needs. An automated service also cannot consider decisions outside of the computer algorithm; for example, whether a client should repay their mortgage rather than consider an investment or make a pension contribution instead of using their ISA allowance.
One of the key drivers towards an automated investment process is cost, and given the lack of human interaction, one would expect the overall cost of a robo-advice service to be low. This is an attraction to some investors who place a low-cost service at the top of their wish list, although we would contend that value for money is a more sensible metric for most investors to consider. That being said, despite the lack of personal advice, robo-advice is not cheap, with platform charges levied by leading UK robo-advisers higher than those charged by direct and advisor platforms who offer access to a wide range of fund options.
Despite the higher charges, robo-advisers are struggling to gain traction, and the high financial cost of establishing the service and infrastructure, together with marketing in a crowded space, means that many services are some distance from profitability. Not helping this struggle is the average investment size held on robo-advice platforms. One of the biggest advantages robo-advice can offer is the ability to handle small investments, and many services do not stipulate a minimum investment size. Whilst this may increase user numbers, firms will struggle to make significant progress handling smaller portfolios. Global data compiled by Statista shows that the average size of a robo-advice portfolio is under £5,000, and if this trend continues over the longer term, charges may have to increase or service levels could fall, as firms try and move towards profitability.
It is clear that robo-advice has a place in the crowded financial services marketplace, although they may struggle to gain mainstream traction. They have, however, provided positive benefits to the industry and have almost certainly helped push a digital revolution in the market which has been adopted by most providers, who now provide easy-to-use online access to funds held on their platform. This has also helped drive down costs and improve service levels offered by mainstream providers.
Whilst some may be happy to use a robo-advice service, we feel this is no substitute for independent human financial advice. Leaving investment decisions to a computer algorithm has the potential to lead to an investment portfolio that doesn’t suit an individual’s requirements, and not being able to factor in wider financial planning needs or tax considerations places robo-advice at a distinct disadvantage. Speak to one of our advisers for impartial, tailored advice with human interaction.
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The value of investments and the income they produce can fall as well as rise. You may get back less than you invested. Past performance is not a reliable indicator of future performance. Investing in stocks and shares should be regarded as a long term investment and should fit in with your overall attitude to risk and your financial circumstance.
