Basic info about Robo Advisors

I always wanted to know what is this investing with Robo Advisors. But never got around to know about it till this week. Finally, I spent some time to know what is it all about and here is my simplistic take on it in bullet form.  I attribute this to multiple sources. Enjoy!

What is it

·         One of the channels used to manage your investment portfolio.

·         Fills the middle ground between spending time to invest on your own and engaging an investment advisor to manage your funds

·         It is an automated portfolio management system, based on your specific situation (age, risk tolerance, timeline, present wealth, and saving ability)

·         It uses a combination of ETFs (Stocks and Bond) and rebalances periodically. Some Robo Advisors use Mutual Funds , High net worth investors can go for individual stocks

·         The funds are kept separate from the organizations who manage it

What it is not

·         Rest assured, it is not a ROBOT managing your money

·         Does not replace Financial advisors who provide more than just investment advise

·         Does not replace human

Who benefits from it

·         Everyone, no special category such as millennial, retired, wealthy, sophisticated or business people

Why is it popular

·         Variety of financial tools and education resources

·         Low fees and hence more for you than the middleman

·         Lower risk compared to holding individual stocks

·         Monthly contribution and compounding effect of the growth

·         Flexible fee structure based on premium services offered for complex situations

·         Low turnover of securities and hence low cost

·         Can be used for RRSP, RRIF, TFSA and for individual, joint, corporate, and trust accounts

·         You can have multiple accounts with different investment purposes with the same advisor

·         It eliminates emotional bias in investing

Is it some new fad

·         Robe advisor is around for more than a decade

·         Has been more prevalent in US for a longer time than in Canada

·         Based on Modern Portfolio Theory using algorithmic investing

·         Sound investment policies such as diversification and rebalancing

·         Available in Canada since 2010 – some prominent names include BMO SmartFolio, Idema Investments, WealthSimple

·         Available across Canada (some Robo Advisors are available in select provinces at this time)

·         The AUM grows over 50% per annum

How much is needed to invest

·         Robo advisors success lies in its flexibility for the investible funds

·         The minimum varies between zero dollars to 50,000 depending on the advisors

·         Some Robo Advisors have no minimum to open the account but have a threshold to initiate an investment (such as $2,000)

What is the Investment style

·         Robo advisors use both Passive style and passive-active hybrid

·         Passive-active hybrid adjusts investing based on the market conditions or follows active management of ETF

·         Holds between 4-10 ETFs on an average in a portfolio with average of 7 ETFs

·         May use universe of ETF covering Canadian, USA, Europe and emerging markets) plus fixed income and real estate ETFs.

·         They reinvest dividends

·         Tax loss harvesting and rebalancing as portfolio grows

·         Offers a full range of investment style (Conservative for those with limited means and for those with less risk appetite), Balanced or Growth (more aggressive investment style with longer time horizon and hire risk tolerance)

·         The returns range between 3% for Conservative, 4-6% for Balanced and around 7-8% for Growth oriented investors over longer periods. The returns will be in line with the market performance of the defined asset class combination

Why is the focus on ETF

·         Modern Portfolio theory (of Nobel Prize winner Harry Markowitz) is the foundational principle behind the Robo Advisory services which says that an investor can reap a maximum risk adjusted return by efficient construction of optimal portfolios as opposed to holding individual stocks

·         Robo Advisors scan and select ETFs that mimic some of the specific indices (example TSX, S&P) to diversify the portfolio and reduce the risk

·         They choose ETFs negotiating a low cost Management Expense Ratio (MER) that have high liquidity with minimal tracking error to their underlying index.

·         How much does it cost

·         Much lower than the traditional investment advisor fees that goes up to 2.5% of the asset managed

·         Uses a tiered structure, with lower fees as the asset value increases

·         Average fees ranges up from 0.50% to 0.90% with some minimum (as low as $25/year for a portfolio of $5,000). For a portfolio of $500,000, the fees could be $2,500 /year.

·         Fees payable either monthly or quarterly

·         You still have to bear the cost of ETF fees on top of the advisory fees, however many Robo-advisors are able to negotiate lower yearly management fees for ETFs

·         Many Robo Advisors do not charge trading fee (If you manage your own portfolio, you have to pay for the transaction  costs)  

Can we consult with a live person

·         Some Robo Advisors will open an account only after meeting with you (over phone or face to face), while some allow account opening on-line without any human interaction with only on-line question and answers re your financial position

·         You have 24/7 access to your accounts on-line including statements, and ability to transfer funds to the portfolio from your existing bank account

Is my money safe

·         Robo advisors normally use a third-party custodian (usually set up for the exclusive purpose of holding the investments). Your assets are held in an account in your name and the Robo Advsiors cannot access the money except to the extent of the fees and charges agreed with you.

·         The Robo Advisor issues instructions to the custodian for executing the trades on your behalf as per your risk profile mandated portfolio.

·         Even if the Robo Advisor ceases to operate or taken over by another firm, your funds with the custodian are not dissolved but is managed by the new firm who gets your mandate

·         If the custodian becomes insolvent, the assets under the custodian are protected (currently $1 million/account) by the Canadian Investor Protection Fund (CIPF). There is no cost for this protection and coverage begins as soon as you open the account.

·         Check with your Robo Advisor if they allow their custodian to re-hypothecate your assets. They must not.

Is it the 8th miracle to free me from my financial worries?

·         NO – you are still responsible for your finances. Robo Advisors represent a channel in your financial management. They are not the panacea for all your needs

·         You cannot pick and choose ETFs in your portfolio

·         This is a handsfree investment approach based on YOUR input and an algorithm run by the Robo Advisor company

·         This does not protect you from loss in case on a market crash or an unexpected recession or some calamity

·         The risk is mitigated by way of diversification among various classes of securities and regions

·         They do not provide hand holding financial advise

Who are some of the Robo Advisors in Canada

·         BMO SmartFolio

·         Idema Investments

·         Justwealth

·         Nest Wealth

·         Questrade Portfolio IQ

·         Wealthsimple

·         Virtual Brokers Wealth Mgmt.

Where can I compare or learn more about the Robo Advisors in Canada

Rob Carrick of Globe and Mail produced an excellent article ‘2017 ROBO-ADVISER GUIDE’ comparing Robo Advisors.. Please follow the link (you need to be Globe Investor Subscriber)

https://beta.theglobeandmail.com/globe-investor/funds-and-etfs/etfs/roboadviser-guide-2017-carrick/article36715605/