AI Robo-Advisors are capable of managing portfolios and giving financial advice. Here’s why they may replace human wealth managers. By Michael Megarit.
5 Reasons Why Robo-Advisors are the Financial Industry’s Future
Traditionally, investment advice was provided by professionals with financial degrees and years of experience working with important clients.
Artificial Intelligence (AI) technology is changing this age-old paradigm.
In the early 2000s, software engineers created so-called “Robo-Advisors”, digital platforms that provide automated, algorithm-driven financial services with virtually no human intervention. For nearly 10 years, the technology was reserved for investment professionals who used it to automate basic portfolio management.
In 2008, everything changed: the technology was released on the open market and became accessible to retail investors.
Now, anyone can sign up to an online robo-advising platform and create an automated portfolio in just a few clicks. Gone are the days of having to hire a financial advisor, fill out a ton of paperwork and call them every time you want to buy or sell a particular asset.
Everything is done online without any human assistance.
Thus, it’s no surprise that the industry’s growth is explosive: In 2020, CNBC reported that robo advisors managed more than $460 billion of assets. This figure is expected to reach $1.2 trillion by 2024.
Clearly, AI is transforming the financial industry and experts are predicting the disappearance of human financial advisors.
Is this a reasonable expectation?
Here are 5 reasons why robo-advisors may replace traditional financial advisors.
1 – Robo-Advisors Offer Low Fees
The single greatest argument in favor of Robo-Advisors is the low management fees.
Since they bypass human intervention, Robo-Advisors offer the same standard services for a fraction of the cost.
Most Robo-Advisors charge annual management fees of 0.2-0.5% of the client’s total account balance. In comparison, the cheapest financial advisors charge 1-2% and this figure can rise substantially depending on the type of account you choose.
Why would someone choose to pay substantially more to receive the same services?
2 – Robo-Advisors Facilitate Passive Investing
Warren Buffet famously stated that “passive investing is the best way for the know-nothing investor to beat the returns of most investing professionals”.
In fact, it is now beyond reasonable doubt that passive investing is the average retail investor’s best long-term strategy.
Robo-Advisors capitalize on this by facilitating simple passive investing strategies.
When a client signs up to the platform, the Robo-Advisors collects information about their financial situation, time horizon, risk tolerance and investment objectives. Then, it uses this data to build passive, indexed portfolios that meet the client’s needs.
What’s more, Robo-Advisors are able to diversify and rebalance the client’s portfolio in accordance with their referred asset allocation. Human financial advisors discourage regularly rebalancing because it is time-consuming and expensive due to recurring transaction fees. However, a robo-advisor automatically ensures optimal asset class weightings for almost no cost.
For example, if the client wants 50% exposure to US markets, 25% exposure to commodities and 25% exposure to foreign markets, the robo-advisor will rebalance the portfolio every time the market prices unbalance the weightings. The client simply indicates his preferred weightings and lets the robo-advisor do the work.
3 – They are Accessible and Easy to Use
For the average person, traditional forms of investing can be intimidating.
Most financial advisors prefer managing rich clients with variety of wealth management needs who can afford to pay for their services. Everyday investors with limited financial means are sometimes ignored, treated with contempt or outright scammed.
Robo-Advisors solve this problem because they target everyday investors with ‘normal’ financial means. Most Robo-Advisor platforms require $5K or less to sign up and start investing. This is a major factor that is driving people to these digital financial services platforms.
In addition, Robo-Advisors are available 24 hours a day, 7 days a week, and 52 weeks a year. They never get sick, go on vacation, or avoid your calls. All you need is an internet connection and you can login anytime from anywhere in the world.
Finally, Robo-Advisors make executing trades a seamless process.
Traditionally, executing trades through a financial advisor is a complicated process: the client needs to call the advisor, meet with them, explain why they want to buy or sell a given product, sometimes justify their decision, fill out a lot of paperwork and wait for execution of the trade.
This time consuming process is now done by clicking a few buttons on your personal computer.
4 – Robo-Advisors Guarantee Quality Service
Having access to a professional human financial advisor is convenient and reassuring.
However, you never know if they’re genuinely concerned about your financial well-being or just trying to generate management fees. What’s more, you have no way of knowing if they give the same financial advice to each of their clients: are they touting the same investment opportunities to everyone regardless of net-worth? Or do they play favorites in function of who pays them more fees?
It’s impossible to provide a definite answer to this question. However, it is possible to state unequivocally that robo-advisors are programmed to provide the same quality of financial advice to all clients regardless of their net worth.
This means they won’t look down on you or discriminate if you’re investing small amounts of money.
5 – Robo-Advisors Provide A Wide Array of Services
In the early days, Robo-Advisors were programmed to automate basic investing strategies.
As technology evolves, they become more “competent” at performing complex tasks.
For example, modern Robo-Advisors are able to provide the following services:
- Passive investing strategies (ex: Dollar-Cost Averaging into ETFs)
- Optimized portfolios for specific strategies (ex: Ethical investing, Hallal investing, etc)
- Tax-loss harvesting (ex: offset capital gains taxes while avoiding wash-sale violations)
- Investment selection (choosing the right asset based on your objectives and risk tolerance)
- Retirement planning (determine income goals and implementing strategy to achieve them)
In sum, robo-advisors are becoming “one-stop shop” online platforms where people can manage their investments and receive financial advice affordably.
Will they signal the death of human advisors?
As it turns out, robo-advisors are very useful for automating basic passive investment strategies. However, they are still unable to execute complex wealth management strategies that require subtle subjective judgment and sophisticated hedging techniques.
Thus, we can reasonably expect that human wealth managers providing complex investment advice will survive for years to come.
About the Author
Michael Megarit is a partner with Cebron Group. With over 25 years of domestic and international corporate finance experience, he provides M&A and capital advisory to high-growth technology companies.