Robo-advisor

A robo-advisor is an online wealth management service that provides automated, algorithm-based portfolio management advice. They usually do not get involved in more personal aspects of wealth management, such as tax planning, retirement planning or estate planning.^[1]

Typically the investor fills an online questionnaire to assess his/her risk tolerance and objectives. A phone call or live chat may also occur.^[2] An exchange-traded funds (ETF) portfolio will then be recommended accordingly, out of five to ten standard choices ranging from conservative (more bonds) to aggressive (more stocks).^[3] The ETF portfolio will be automatically maintained by the robo-advisor.

Some robo-advisors have a traditional passive investing approach, using broad-market ETFs with low fees and no market timing. Others have a more active approach, for example using so-called “smart beta” ETFs or variable asset allocations.^[3]

While robo-advisors were initially marketed to millennials, in 2017 the average client was about 44 years old.^[4]

Regulatory model

Robo-advisors operating in Canada are typically licenced as portfolio managers.^[5]

There is no "online advice" exemption from the normal conditions of registration for a portfolio manager (PM). The registration and conduct requirements set out in National Instrument 31-103 Registration Requirements, Exemptions and Ongoing Registrant Obligations (NI 31-103) are "technology neutral". The rules are the same if a PM operates under the traditional model of interacting with clients face-to-face and if a PM uses an online platform.^[6] Often, model portfolios are created using algorithmic software although, again, a registered advising representatives (AR) has responsibility for the suitability of each client’s investments.^[6]

An online questionnaire and interface facilitates much of the "know your client" process, but a live, licensed portfolio manager must review this information and the recommended portfolio to ensure suitability. This review has to be done through what the Canadian Securities Administrators (CSA) calls a "meaningful discussion" between a licensed portfolio manager and each client.^[7]

Costs

As of December 2020, on the first $100k invested, yearly fees range from 0.5% to 0.7%, including the costs of the underlying ETFs, at six of the eight robos reviewed by MoneySense.^[8]

For comparison, the MERs for Asset allocation ETFs -- which offer essentially the same convenience, and are purely passive -- are approximately half of this.

Pros

• Cheaper than traditional investment advisors using mutual funds for moderate-sized portfolios.
• No work for the investor, no knowledge required.
• Less risk of behavioral mistakes.
• Fees are transparent.^[9]

Cons

• Significantly more expensive than buying the very same ETFs, or another model portfolio of low-cost ETFs, at a discount broker yourself and rebalancing occasionally.
• Also significantly more expensive than buying a single asset allocation ETF, which requires no rebalancing
• There may be significant changes in asset allocation over time within the portfolios: in one example, US stocks went from 15% to 32.5% over a 2.5 year period, without the investor having any control over it^[10]
• Portfolio recommendations may not take into account factors such as job type or stability, workplace pensions, etc.^[2][11]
• If the robo-advisor uses an active approach, results may be better or worse than a passive approach: the active strategies add uncertainty.
• Some of the ETFs used by robo-advisors have high fees and/or have a short track record.
• Some robo-advisors are now promoting active stock trading and trading in highly volatile cryptocurrencies, which go completely against the original "good-for-you" philosophy^[12]

Alternatives

• An investor willing to pay 1% per year for a hands-off diversified portfolio should also consider one fund porfolios, including relatively low-cost balanced funds.

See also

• Getting started
• Portfolio design and construction

References

Further reading

• Financial Wisdom Forum topic: "Robo-advisors"
• Financial Wisdom Forum topic: "Robot Wealth Managers"

External links

An actual experience with a Canadian robo-advisor, from Aman Raina at the Financial Independence Hub:

• Robo Advisors, A Personal Experience Part 1: Getting Started, February 23, 2015,
• Putting a Robo-Adviser to the Test, Part 2 (a), March 17, 2015.
• Putting a ROBO adviser to the test, Part 2 (b), March 18, 2015.
• Aman Raina’s Robo portfolio — 2 years later, February 24, 2017
• Aman Raina’s 3-year review of his Robo Advisor portfolio, March 2, 2018: "In the three years I’ve had the portfolio, my ROBO has made changes in the asset allocation three times and has turned over 75% of the portfolio. So if you expect a “set-it and forge it” strategy, you won’t find it here"
• Aman Raina’s 4-year Robo Advisor review, March 7, 2019: "The US portion now has 2 ETFs that invest in the same basket of US stocks, which I continue to look at in bewilderment."
• Aman Raina’s mid-year ROBO advisor review, November 18, 2019: "This marks the 3rd significant change in my portfolio’s asset allocation in the 4 1/2 years I’ve had the portfolio. I think we can clearly say this portfolio has not been passively managed."
• Aman Raina’s 5-year Robo advisor review, March 27, 2020