A robo-advisor is an online wealth management service that provides automated, algorithm-based portfolio management advice. They usually do not get involved in more personal aspects of wealth management, such as tax planning, retirement planning or estate planning.
Typically the investor fills an online questionnaire to assess his/her risk tolerance and objectives. A phone call or live chat may also occur. An exchange-traded funds (ETF) portfolio will then be recommended accordingly, out of five to ten standard choices ranging from conservative (more bonds) to aggressive (more stocks). The ETF portfolio will be automatically maintained by the robo-advisor.
Some robo-advisors have a traditional passive investing approach, using broad-market ETFs with low fees and no market timing. Others have a more active approach, for example using so-called “smart beta” ETFs or variable asset allocations.
There is no “online advice” exemption from the normal conditions of registration for a portfolio manager (PM). The registration and conduct requirements set out in National Instrument 31-103 Registration Requirements, Exemptions and Ongoing Registrant Obligations (NI 31-103) are “technology neutral”. The rules are the same if a PM operates under the traditional model of interacting with clients face-to-face and if a PM uses an online platform. Often, model portfolios are created using algorithmic software although, again, a registered advising representatives (AR) has responsibility for the suitability of each client’s investments.
An online questionnaire and interface facilitates much of the "know your client" process, but a live, licensed portfolio manager must review this information and the recommended portfolio to ensure suitability. This review has to be done through what the Canadian Securities Administrators (CSA) calls a "meaningful discussion" between a licensed portfolio manager and each client.
As of May 2016, on a $5000 portfolio, yearly fees range from 0.3-6.9% including the costs of the underlying ETFs. For a $50 000 portfolio, the same fees range from 0.7-1.1%. On a $200 000 portfolio, fees are in the 0.7-1.0% range.
- Cheaper than traditional investment advisors using mutual funds for moderate-sized portfolios.
- No work for the investor, no knowledge required.
- Less risk of behavioral mistakes.
- Fees are transparent.
- Significantly more expensive than buying the very same ETFs, or another model portfolio of low-cost ETFs, at a discount broker yourself and rebalancing occasionally.
- Portfolio recommendations may not take into account factors such as job type or stability, workplace pensions, etc.
- If the robo-advisor uses an active approach, results may be better or worse than a passive approach: the active strategies add uncertainty.
- Some of the ETFs used by robo-advisors have high fees and/or have a short track record.
- An investor willing to pay 1% per year for a hands-off diversified portfolio should also consider one fund porfolios, including relatively low-cost balanced funds.
Doing it yourself
The steps performed by the robo-advisor in exchange of what are still high fees are not rocket science, and are not as complex or time-consuming as you may think. Investors in search of much lower annual costs, and who can stay the course, will therefore opt for the DIY route, with index funds or ETFs.
- Risk tolerance questionnaires are available freely online.
- Model portfolios can be found in simple index portfolios or at Canadian Couch Potato.
- For frequent purchases, including automated regular contributions, index funds are the easiest route and do not require a brokerage account. The example presented in four index funds has a weighted average cost of 0.44% as of December 2016.
- For larger portfolios and infrequent purchases, ETFs have lower costs: the example of three ETFs has an average MER of 0.15%, to which trading commissions must be added.
- If you have selected your asset allocation but are intimidated by the vast array of ETFs available, see the very low-cost broad market cap-weighted ETFs listed in the following pages: Canadian bonds, Canadian equities, US equities and International equities. See also Recommended Funds
- If you have never used a discount brokerage account, see the helpful videos listed at How to build an ETF portfolio at...
- If you are concerned about the details of rebalancing, see the detailed examples in Strategies for rebalancing.
- If the world stock markets are down quite a bit and you are panicking, before you sell everything, get moral support for free from the Financial Wisdom Forum!
- Robo-Advisor, Investopedia, viewed December 3, 2016
- David Israelson, The robo-adviser choices grow in Canada, The Globe and Mail, June 18, 2016, viewed December 3, 2016
- David Aston, Find out if you should go robo, MoneySense, May 18, 2016 (subscription required)
- "CSA Staff Notice 31-342 Guidance for Portfolio Managers Regarding Online Advice". Canadian Securities Administrators. September 24, 2015. http://www.osc.gov.on.ca/documents/en/Securities-Category3/csa_20150924_31-342_portfolio-managers-online-advice.pdf. Retrieved December 17, 2016.
- Dan Hallett (September 2016). "Scalability is a huge issue for robo-advisors". Investment Executive. http://www.investmentexecutive.com/-/growing-pains. Retrieved December 17, 2016.
- Paul Brent, What to consider when deciding whether to use robo-advisers, The Globe and Mail, June 17, 2016
- Guy Dixon, Automation takes the emotion out of the investing equation, The Globe and Mail, June 17, 2016
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An actual experience with a robo-advisor, from the Financial Independence Hub:
- Robo Advisors, A Personal Experience Part 1: Getting Started, Aman Raina, February 23, 2015,
- Putting a Robo-Adviser to the Test, Part 2 (a), Aman Raina, March 17, 2015.
- Putting a ROBO adviser to the test, Part 2 (b), Aman Raina, March 18, 2015.