One of the biggest trends playing out in the financial technology universe is the rise of robo-advisors which strives to help young people invest in their future. A robo-advisor is sort-of what the name implies: a robot (i.e digital) advisor created by experts which offer financial advice and serves as a replacement for human advisors that are often more expensive.

Why A Robo-Advisor?

Robo-advisors gather personal financial information from customers through surveys and questionnaires and then use automation and other smart technologies to create a personalized financial plan. Some of the questions would include how long until you plan on withdrawing your capital or when investing in stocks what level of risk would you tolerate.

Needless to say, a robo-advisor is built from the ground-up by financial experts so clients can sleep easily at night knowing their money isn’t being fully managed by software and algorithms.

Robo-advisors are mostly targeted towards younger people who are attracted to modern technology and the “disruption” nature of the industry. But robo-advisors can be used by anyone across all income brackets and financial situations.

Some robo-advisors offer additional value-added services, like the ability to interact with a human for whatever reason. Some customers may want to discuss their financial goals and objectives with a human if they don’t have a clear grasp of their own objectives.

Gone are the days of dealing with financial professionals who could take advantage of their clients by pushing products that generate commission for them.

MDJ’s Wealthsimple review shows that the robo-advisor has a fiduciary duty to ensure clients receive advice that is 100% consistent with their financial objectives and risk tolerance level. In fact, this is not the norm across human financial advisors in Canada. Standard practice across many big banks is to recommend mutual funds or other financial products without a similar legal fiduciary obligation.

Is It Safe?

Robo-advisors that operate in Canada and other elsewhere should only be selected by a consumer if they follow existing rules and regulations which cover the broader financial planning industry.

Most notably, a robo-advisor that is recognized by the government would qualify for the same insurance in the event the firm goes bankrupt. In Canada, the CIPF guarantees consumers up to $1 million in the event of bankruptcy.

In terms of online privacy and security, most robo-advisors make use of bank-level security with the standard being a 128-bit SSL certificate.

It would be up to each individual potential client to properly research one or many robo-advisor companies before handing over their money. This logic should be universally applied and there are some steps to perform to ensure a smooth and enjoyable experience. Some of the more common tips include asking family and friends for personal referrals and making sure someone in the customer support department picks up the phone and willing to offer friendly help and advice.

So How Much Do They Cost?

Fees vary by company but a good starting point is to assume a robo-advisor charges consumers an annual fee equal to 0.5% the size of their account. The fee is mostly all-inclusive and covers trading transactions, account fees, rebalancing, among other costs that other investment firms are notorious for charging.

Consumers with an account size generally north of $100,000 will likely qualify for a discounted fee. This could be seen as a strategy to attract a client segment that is likely to earn a larger income and more likely to seek advice from their bank or another expert.

At first glance, robo-advisors are certainly cheaper than their human rivals who charge fees north of 1% for their service. Mutual fund investors can expect to pay among some of the highest fees in the world at around 2%.

Other asset managers, like hedge funds, charge customers fees above and beyond 2% in addition to a commission on all profits generated each year.

But Is It Worth It?

So this begs the question: is it worth it to pay for a robo-advisor? The answer isn’t as simple as yes. As the old saying goes “you get what you pay for.”

A robo-advisor is typically designed to help customers invest for the long-term. As such, they make use of passive investing strategies which means the robo-advisor will recommend an investment strategy to generate returns that are consistent with major stock indices, such as the Dow Jones Industrial Average or TSX Venture 50.

By comparison, a human financial advisor can be asked by their client to generate an investment strategy that will yield returns above and beyond the market. Unlike a piece of software, a human advisor can seek out knowledge and information above and beyond what a robo-advisor is “trained” to do as part of its software language.

For example, a human financial planner could have particular experience in seeking out companies that are undervalued and trades at a discount to their intrinsic value. Or, a human advisor who pays particularly close attention to the stock market rumors can position a client’s portfolio to take advantage of a merger that Wall Street analysts are predicting.

Comparing Returns

Another important factor in determining if a robo-advisor is worth the lower fee is to evaluate the total return. After all, a consumer who pays 0.5% in fees for a 5% return would likely be more than happy to switch to a human advisor who charges 2% but generates a superior 10% return.

It is impossible for robo-advisors to guarantee a rate of return, and companies go out of their way to emphasize this reality to prospective clients. The only way to evaluate returns is unfortunately after the fact.

It is very easy to spend a year or two with a robo-advisor and collect readily available public data on mutual fund performances for an accurate side-by-side comparison.

Intangible Benefits

Choosing between a robo-advisor and a human advisor should include some intangible benefits that have no direct financial cost, like the ease of use.

Most if not all robo-advisors will make use of apps that are heavy with data that can be customized based on specific preferences. By comparison, some human advisors are mostly only available through a phone call or in-person meeting — that is when they aren’t busy attending to other aspects of their business.

Robo-advisors also can’t pick and choose which clients have priority based on their account size. Every client has access to the exact same software, tools, and information on an app.

The Bottom Line: Give It A Try

Investing with a robo-advisor can be an exciting experience, especially for young investors looking to start investing their money. After all, the name robo-advisor sounds pretty cool and certainly makes for an interesting topic of conversation over dinner. Human advisors also tend to target individuals who are close to retiring or have already retired.

If a consumer isn’t happy with the robo-advisor they are more than free to switch to a human advisor. The earlier someone starts investing in their future, the sooner they will be able to discover which products and services work best for them.