-By Shefali Sahu
In a world where smartphone manages our daily activities and AI solves our complex problems, why do investors still trust the financial advice human advisors give? The smart innovation of Robo-Advisors, where algorithms and artificial intelligence empower wealth management is yet to be explored.
"Robo-Advisors" is an online investment platform offering automated, algorithm-driven financial planning and investment services with little human supervision. These digital platforms democratize investing by making sophisticated portfolio management accessible to investors.
Now let’s examine whether Robo-Advisors are the future of wealth management, or just another fleeting tech trend, by reviewing the working, benefits, limitations, and their impact on financial management.
History of Robo-Advisors
The need for alternative financial advisors arose due to the late 2000s post-financial crisis, and the investor's need for transparency in investment management. Due to the recession, there was a huge decline in economic activity, and as a result, investors were looking for cost-effective ways to invest.
This crisis marked the innovation of automated virtual financial advisors. Wealthfront in 2008, and Betterment in 2011 had first mover advantage as Robo-Advisor platform. After that, there are currently 100 Robo-Advisors in 15 countries.
McKinsey & Well Company's research study on the Global Robo-Advisor market finds that the market of Robo-Advisors reached a value of USD 4636.99 million in 2022. In 2023, The Vanguard Group was one of the major players, holding a share of 12.99% in 2023.
Looking at the growth of Robo-Advisors, continuous investments are being made in this sector like –
Groww an Indian Robo-Advisor raised $83 million in Series D funding, making it a unicorn, valuing the company at over $1 billion.
JPMorgan Chase acquired Nutmeg the UK-based Robo-Advisor in 2021 for £700 million, to upgrade the traditional wealth management market.
Streamline Your Wealth: Key Features of Robo-Advisors
Robo-Advisors streamline the wealth of investors with the following common features
Automated Investing – Once an investor fills out the questionnaire, it’s the Robo-Advisor's job to allocate the portfolio. The investor is not at all involved in choosing the investment option. Robo-Advisor does it with the help of algorithms.
Automatic Rebalancing – To keep an investor’s financial goal in line, the Robo-Advisor rebalances the portfolio based on the market performance. Rebalancing keeps the portfolio in check.
Tax-Loss Harvesting – Robo-Advisors optimize the portfolio to maintain tax efficiency. Some Robo-Advisors like Betterment and Wealthfront offer their investors tax loss harvesting services, in which the investments that are in loss are sold in a tax-efficient way to counteract capital gain tax. These platforms don’t charge extra fees for this service. Wealthfront has estimated that investors can gain an additional average of 1.8% annual returns because of Tax-loss harvesting.
Integrated financial planning tools – Many robo-advisors integrate financial and budgeting tools, making it simple for investors to enhance financial literacy. It becomes easy for them to understand personal finance.
How Robo-Advisors Simplify Investing
From Algorithms to returns, let’s understand how Robo-Advisor manages an investor’s money
Whenever an investor opts for any Robo-Advisory service, he is asked first to fill out the questionnaire, in which questions related to financial goals, risk tolerance, and current financial situation are asked. This helps a Robo-Advisor to assess your investment objectives and preferences.
Now with the help of algorithms, based on the responses, a Robo-Advisor offers a personalized investment strategy or portfolio allocation across various asset classes, including bonds, stocks, ETFs, etc.
Once an investor buys the assets that a Robo-Advisor has recommended, then it will manage the assets, and make changes according to the market, and an investor’s need. This is known as automated rebalancing of portfolios.
The Digital vs. Human Approach: Understanding the Key Differences
The major difference between financial and traditional advisors is their place of conduct. If you choose Robo-Advisor for your investment management decision, you must consult virtually with it. Other differences between them are –
Affordability
The cost that a Robo-Advisor charges is based on the percentage of the assets managed. Roughly, they charge around 0.25%-0.50% annually.
Financial advisors on the other hand charge hourly fees on the percentage of assets managed. Because of this, opting for financial advisors becomes costly for some people.
Accessibility
Investors can access to Robo-Advisor services only through mobile apps, or online platforms, because of which it offers convenience to access anytime, and anywhere.
When it comes to a financial advisor, it has limited access, because you can only meet the advisor in schedule meetings, email, and phone calls. Due to this, investors often don’t feel convenient to access financial advisors.
Customization
Robo-Advisors offers limited customization to the investors. They have no say in their portfolio management. As a robot-advisor has advised, they cannot counteract if they are unwilling to invest in a particular asset.
When it comes to a human advisor, an investor can schedule a meeting, and ask about his portfolio, and also, he can customize his portfolio according to his convenience.
Biases
A Robo-Advisor is not biased in making investment decisions for an investor, because it’s all done with the help of algorithms.
A financial advisor on the other hand may be biased while designing the portfolio for its investors.
Navigating the Downsides: Key Limitations of Robo-Advisors
Robo-Advisors offer ease in investing by fully managing the portfolio on investors. They also have certain limitations like -
Limited human interaction – The interaction with Robo-Advisors is fully automated. An investor faces one drawback here if he wants to consult regarding a market situation, or he wants to give his input in investment decisions, he is restricted from doing it.
Risk Tolerance Misalingement – The robo-advisor analyses the risk-taking ability of an investor through the questionnaire he filled out. There might be chances that it might not analyze the full scope of an investor’s comfort with risk, in situations like financial crises.
Over-Reliance on Algorithms – The major drawback of algorithms is that they follow historical data and patterns to make the decisions, because of this, they might not accurately predict the market behavior. They may account for some resistance to sudden market changes.
Complex Financial Planning –As robo-advisors are designed for all global investors. Their investment decision for a particular investor will be based on considering all the investors. Due to this, it ignores major life events like buying a house, any financial uncertainty, etc. which make an investor’s portfolio unattractive.
Are Robo-Advisors an efficient substitute for human financial advice?
To arrive at this conclusion, I researched 68 investors. My research sample includes 57.4% working professionals and 42.6% MBA students. Among all the investors on which I did research, 60.3% are aware of what Robo-Advisors are.
Among all the investors, only 7.8% use a Robo-Advisor to make their investment decisions. The remaining 92.2% either invest by doing their research, or through human financial advisors.
Among those who don’t use a robo-advisor in their portfolio management, it was found that 68.8% of investors think that a robo-advisor offers complex financial planning, 54.2% don’t use a robo-advisor because of limited human interaction, 50% believe that robo-advisors have over-reliance on algorithms, and 10.4% don’t choose a robo-advisor because they feel that robo-advisors misalign risk tolerance.
Among those investors who use Robo-Advisor, the primary reason for choosing 50% of investors is automated portfolio management, and for 50% of investors, it's a strong investment performance. 50% of investors experienced automated portfolio management and rebalancing as a primary benefit of opting for a robo-advisor, and 25% experienced ease in setting up and managing investments online. The other 25% experienced the benefit of cost saving.
Among investors who use a robo-advisor for investment, 75% think a robo-advisor must have more personalized investment advice. The remaining 25% believe it should have more investment options for diversification.
One drawback of awareness of Robo-Advsiors in the context of the benefits the investor can get if he chooses a robo-advisor for investment planning, I found in my research is the lack of promotion. 59.6% of investors learned about Robo-Advisors through their family and friends, and 40.4% from financial news/papers. None of the investors got to know through advertising. This can be one of the reasons why investors are not confident about choosing Robo-Advisors for their financial planning.
CONCLUSION
Robo-Adviors though can ease the investment decision of investors. Still, they come up with certain challenges like lack of personal guidance, and customization, because of which investors restrict themselves from opting for this high-end technology for their investment decision. As technology constitutes advancements for consumers' comfort, companies' constant investment in this sector will revolutionize how investors build and manage wealth in the 21st century.
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