What are Robo-advisors?
This latest edition of our student blog series comes from Sara Thu who is currently pursuing an MSc in Financial Technology (FinTech) at UWE Bristol.
In this age of rapid technology development, everyone seems to be talking about robo-advisors. So what are they? The term robo-adviser conjures up images of robots sitting across the table from you and assessing your investment options. In reality, it’s something of a misnomer – as robo-advisers don’t involve robots and don’t typically give financial advice. A robo-advisor is financial investment services software, operated by financial intermediary, based on trained algorithms and artificial intelligence (AI) that makes investments on investor’s behalf online. They determine suitable investment choices according to your overall investment scenario with low cost. The investment process includes two phases. Firstly, the investment portfolio is created by asking several predefined questions (for example: age, income, family background, investment amount, risk appetitie and the ability to bear losses) leads to resembling classical fund management if the algorithm detects deviations from the specified asset ratio in the customer’s portfolio.
Why are they attractive to investors?
The main reason is their cost-efficiency. Unlike traditional financial advisors, they are low in cost as they recommend investing in Mutual funds, Investment funds and Exchanged Traded funds which are low in cost but higher return for investors in the long-run. Additionally, they are low in annual fee charges which is typically 0.25% to 0.50% regarding to their Asset under Management (AuM). Traditional investors will charge 1% regarding to their AuM. As an example, on an investment balance of £100,000, a 0.25% robo-advisor fee would amount to £250 a year—while a 1.0% fee would equal £1,000 a year plus an hourly advice fees or commissions on particular securities that are bought or sold.
Another crucial factor is that robo-advisors allow you to get started with as little as £10 or less, unlike traditional advisors, as they may need a large sum of investment to kick off. This is beneficial for newer investors who do not have enough cash to invest yet so these are why robo-advisors are appealing.
How do they gain trust from investors?
For robo-advisors, trust is established through low-cost structure, transparency and the evident uniformity of recommendations generated by algorithms. However, like other self-service technologies (SSTs), using robo-advisors may cause anxiety and stress for some investors. By using robo-advisor, it is difficult to form the relationship with investors and develop social rapport.
Nevertheless, to the tech-savvy investors who value efficiency and simplicity, robo-advisors appeal because of their user-friendly and round-the-clock (24/7) accessible nature. Some investors prefer traditional financial advisors because they can discuss complex financial matters and be provided with bespoke solutions which lead to easily building trust based on personal relationships, face-to-face interactions, and a good reputation.
What are their biases?
The biases that robo-advisors are facing while investing are algorithmic as the system is designed and trained by human thus may unintentionally cause biases. Furthermore, while robo-advisors are not subject to emotional biases, they also lack the intuition and qualitative judgment that human advisors can apply in complex or rapidly changing market conditions. The human advisor also has confirmation biases which means they may favour information or historical performance that confirm the initial believes or hypotheses, excluding the market nature. They also can face conflict of interests where they recommend products which are beneficial to the advisors (themselves) rather than the investors. As a result, even when human advisors contribute expertise and intuition to investing decisions, a variety of psychological biases are affected in the decisions. Conversely, robo-advisors provide a more methodical, data-driven approach, but on the other hand, the algorithms, and data they employ may have limitationswith regard to the big picture of what investors want.
Are robo-advisors suitable for all investors?
No, they are not for everyone. If your financial situation is complicated or you want to invest in more than index ETFs or a very limited selection of other securities, it might make more sense to work with a financial advisor. For example, if you are investing on retirement or college funds, a robo-advisor could be suitable, however if you are investing in complicated cases such as tax-optimisation and estate planning, a traditional advisory service might be the right choice.
In conclusion, robo-advisors and traditional financial advisors serve different clientele with a variety of requirements and preferences. For clients with complicated investing needs and those seeking comprehensive financial planning, traditional advisers provide a high-touch, individualised service. Robo-advisors, on the other hand, provide clients who want a hands-off approach to investing a clear, cost-effective, and efficient alternative. It is essential for clients to comprehend these to make well-informed decisions that suit their preferences and financial objectives.