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5 Reasons You Need To Be On The Robo Adviser Bandwagon

5 Reasons You Need To Be On The Robo Adviser Bandwagon

Over the last decade, a number of technology-based improvements have been brought to the financial services industry, including integrated mobile payment solutions, crowd-based lending platforms, digital alternative credit checks, mobile wallets, payments banks, crowd-funding platforms, and financial dashboards. While each new entrant to the financial technology arena has its merits, one of the most promising for investors is the creation of robo-adviser – an algorithm-based, automated portfolio management system, designed to meet the needs of a diverse group of investors. This technology is fairly new to India and several startups and well established incumbents are using it to address customer needs.

Let’s look at a few advantages that this technology might deliver for the consumer:

No emotions

Robo Advisers handle the investor’s portfolio needs, and attempt to deliver performance as per a set plan without emotional factors, unlike human advisors, who may be swayed by emotions. Humans come hard-wired with cognitive biases that often lead them to make suboptimal financial decisions. Research shows that sometimes people see patterns in data where none exist, they sometimes even believe that they are more knowledgeable or skillful than they actually are, and overlook potentially important information, even when it may be obvious. Emotional factors play so much of a role that there has developed an entire line of financial analysis called behavioral finance and business schools offer classes on the subject these days. Robos can effectively help you avoid these biases.

World Class Asset Management Algorithms

Robo-advisers utilize an algorithm to determine the best allocation for an investor’s assets, based on the fundamentals of the Nobel Prize winning economist Harry Markowitz’s modern portfolio theory. Wixifi is the only robo investment advisory service in India, which has an algorithm with published back test results since 2007. The investor has to see the mutual fund orders and approve them before they are sent for subscription or redemption. So far quantitative algorithms were only available to large family offices, sovereign wealth funds, pension funds and large players. Robo advisers are bringing high-tech long term quantitative investment strategies to every investor. It is often wrongly believed that anything that involves an algorithm means changing the portfolio very often whereas several quantitative strategies can be applied to long term investing as well.

Convenience driven by digital transactions

The customer acquisition costs, and time constraints faced by traditional human advisors, have left many middle-class investors ill-advised, or unable to obtain portfolio management services, because of the minimums imposed on investable assets. Robo-adviser services are designed and structured in a customer-friendly way so as to ensure easy navigation. The liberal use of pictures, videos, graphs, and interactive displays, combined with comprehensive explanations of the processes and technical subjects provides a comfortable viewing experience. Many robo-advisers have platforms on a variety of electronic media, including smartphones, so clients have 24-hour access wherever they are. Electronic account statements, trade confirmations, account and commercial bank activity, portfolio positions, and detailed tax information are readily available, including historical information. They also send rebalance reminders, which eliminates the need to manually enter calendar reminders. Quick paperless execution ensure zilch manual calculations. Physical mutual fund transactions are highly tedious and all robo advisers give you the advantage of convenience via digitizing the process.

Lower cost driven by ETFs and direct plans

Some robo-advisers offer investors a low-cost alternative to the traditional financial adviser or mutual fund distributor experience. Some platforms offer a diverse group of low-cost passively managed index funds or direct plans of mutual funds which do not have the fee component in them. Overseas many robo-advisers use ETFs (Exchange traded funds) but as the number of ETFs is still not very large in India most robo advisors in India recommend mutual funds. The typical investment advisor charges around 1% per year of assets under management, which is more than double what a robo adviser could charge and sometimes even 4 times. Total investment returns are severely affected by high fees – a 1% per year versus a 2% per year total fee could mean paying 25% of the invested amount extra as fees over a 10 year period. At this juncture it would also be important to note that not all robo-advisers offer direct plans or ETFs and these robos are not going to give you the advantage of lower expense ratio portfolios. Ironically many of the robo adivsers distributing regular plans with higher cost portfolios (relative to direct plans) advertise their services as free because they do not directly charge the client anything. Needless to say before investing in any kind of product it would be prudent to understand the cost structure well.

Direct plans: Interest aligned with the investor

Regular plan distribution typically means that the distributor is compensated by the Asset Management Company (Mutual Fund House). In cases where the fee of the fund is higher the AMC has more to share with the distributor which could mean that the distributor is incentivized to sell funds with higher fees. Some robo-advisers distribute direct plans and charge you separately for your services. In this model the robo-adviser is not compensated by the mutual fund. You directly pay the robo-adviser for example as a fixed percentage of assets which incentivizes the robo-adviser to recommend funds which are likely to be suitable for you so that you stick around for the long run. As mentioned earlier those robo advisers that are recommending regular plans (instead of the low cost direct plans) are unlikely to deliver this advantage.

Overall robos may give you at least two or more of the aforementioned advantages. What’s most interesting is that like most spaces a few of these factors are India specific. Please do let us know your thoughts on robo-advisor technology.

Note: The views and opinions expressed are solely those of the author and does not necessarily reflect the views held by Inc42, its creators or employees. Inc42 is not responsible for the accuracy of any of the information supplied by guest bloggers.