Explaining robo-advice

Article by Chris Brycki, CEO & Founder of Stockspot, first published in Equity, July 2017

When Stockspot was founded in 2013 most people were not aware of the term ‘robo-advice’. Fast forward to 2017 and ‘robo-advice’ is now a buzzword within investing circles and it’s gaining widespread acceptance as the future for personal wealth management around the globe.

However, the word “robo-advice” doesn’t really explain what it is robo-advisers do.

Some background

Robo-advice started in the US around 2010 and quickly expanded across the globe. Stockspot was the first robo-adviser to launch in Australia, offering a complete digital investing experience and access to a personalised portfolio. Robo-advice initially referred to just investing services however in Australia it is now used to broadly include other digital advice services including insurance.

What is it and how does it work?

Robo-advice makes personalised recommendations on how best to invest your money and uses technology to automate many of the tasks a human financial adviser or fund manager would have done manually in the past.

A lot of those tasks, like understanding your risk capacity and rebalancing your portfolio, can be done automatically using algorithms. It means we can reduce costs and minimise human error. It’s completely online; you can say goodbye to endless paperwork and visiting an investment adviser in a stuffy office.

To invest with a robo-adviser it is simply a matter of going online, answering some questions about your financial goals, investment time frame and attitude to risk. The robo-adviser will provide you with a statement of advice and recommend an investment strategy. If you decide to invest the robo-adviser will then manage your portfolio.

What to watch out for

The statement of advice is important. A robo-adviser will ask personal questions about your financial situation. If you don’t get a statement of advice it’s not personalised investment advice.

Equally, if you have to leave your home to talk to an adviser it’s not robo-advice.

Transparency is important. Robo-advice was born out frustration at the biased advice traditional advisers give clients. Many human financial advisers get paid to recommend certain financial products, regardless of whether it’s good for you or not.

A true robo-adviser does not take any payments from the funds they recommend. Robo-advisers only invest in what we believe will give you the best investment results.

Robo-advisers invest in ETFs

Instead of investing in one or two companies on the stock market, an ETF (Exchange Traded Fund) tracks the broader market or index like the top 200 Australian companies or the largest 100 companies in the world. You get exposure to lots of different markets and assets across the world, which gives you a well-balanced portfolio. You don’t need to pick individual stocks or time the market.

Robo-advisers therefore build portfolios from ETFs comprised of underlying investments in over 1,400 shares and bonds from Australia and the rest of the world. ETFs are selected on how they complement each other to help smooth out short-term ups and down in the market and improve returns.

Robo-advisers understandably prefer ETFs over actively managed funds because they charge lower fees and have generally delivered better returns after fees. The less fees you pay, the more returns you keep!

Given the confusion about robo-advice, here are the top three myths about robo-advice.

Robots invest your money

This is why the robo-adviser term is confusing. It suggests there are robots making the investment decisions in the background, that couldn’t be further from the truth. The reality is there are experienced, smart investment managers overseeing the portfolios.

Robo-advice is only for millennials or new investors

We disagree. Our research shows the high fees attached to most investment funds make traditional advice expensive for larger clients too. Many SMSFs and high-net-worth clients are turning to robo-advice to manage their investment portfolios. Robo-advisers look after balances of anywhere from $2,000 to over $1 million, and clients range from 18 to 80 years old.

Robo-advice can’t substitute for human advice

It’s a popular myth but the evidence doesn’t stack up. Human advisers have a poor track record of letting their emotions (as well as financial incentives) get in the way of sensible investment decisions. Instead of adding risk when things are going well, true robo-advisers take the opposite approach of reducing exposure to profitable investments after periods of gains. Rebalancing this way is industry best-practice and much easier for an algorithm to manage than a human adviser who is prone to herd mentality.

The future

The Business Insider Robo-Advising Report forecasts that robo-advisers will manage around 10% of total global assets under management (AUM) by 2020. This equates to around $8 trillion US.

True robo-advisers aim to make wealth management accessible to more Australians and provide unbiased investment advice and portfolio management. The advent of technology teaming up with finance makes this possible and has fundamentally changed the investment industry, making it more accessible, affordable and honest.