Robo-advisory in banking: do you trust a robot’s financial advice?Robo-advisors are starting to disrupt traditional service models and product delivery in wealth management, but can computers really replace humans in providing good financial advice?
The industry of wealth management is being transformed as a new generation of small investors begin to take advantage of online robo-advisors that are providing a more cost-effective form of portfolio management.
This disruption has opened up the market, which many believe is urgently needed. There is growing concern that not enough people are receiving the financial advice they need at prices that are affordable. The need for more informal and affordable advice is fuelling the rise in robo-advisors, which are seen by some as a solution to this problem.
As the name suggests, a robo-advisor is not a person but an automated online service that provides algorithm based portfolio management. Investors can go online and answer a series of questions on their investment objectives and receive financial advice for much lower costs than traditional financial advisors.
Robo-advisors use the same software as traditional financial advisors but focus mainly on portfolio management and do not get involved in more personal aspects of wealth management, such as tax and retirement.
The rise in the popularity of robo-advisors has been credited in some quarters with digitally savvy millennials who are more comfortable and open to the idea of receiving financial advice online.
However, a more likely and significant factor is that unlike traditional financial advisors, robo-advisors charge much lower fees, along with lower minimum investment requirements.
This has benefited younger investors and others who have yet to accumulate a large amount of wealth but still want their portfolios professionally managed.
It is in the United States where robo-advisors have moved firmly into the mainstream of financial advice with firms such as Betterment, Wealthfront and Personal Capital leading the way.
Larger asset managers like Vanguard Asset Management are also adopting the technology with their personal advisor service, which combines web-based advice and investment-modelling algorithms with human contact.
In the UK, the Financial Conduct Authority (FCA) confirmed in a report published in March 2016 that a dedicated team inside the Authority would help bring robo-advice to the mass market.
As part of its long awaited Retail Distribution Review (RDR), the FCA approved the use of robo-advice as an alternative to costly face-to-face advisors, which help to reduce costs for investors.
The desire to increase the availability of robo-advisors is part of a policy to expand the financial advice market. The view of the FCA is that the market currently delivers high-quality solutions for those investors that can afford full advice. However, not every potential investor requires or wants a personal recommendation for every decision – in this context, robo-advisors have an important role to play.
Robo-advisors should be viewed as a service that compliments traditional wealth management advice rather than one that seeks to replace it – they each address different client needs and goals.
The evolution of robo-advisors will continue, after beginning as a simple online questionnaire with a limited set of products, strategies and minimal fund management.
Advances in technology mean robo-advisors are moving more towards dedicated fund management, involving adjustments, rebalancing and allocations based on the risk appetite of investors.
For all the potential benefits robo-advisors can bring, face-to-face interaction will remain of vital importance in wealth management. In times of uncertainty and volatility, investors will ultimately seek the guidance of people over machines.
What is clear is that new technologies are playing a significant role in opening up the wealth management market and providing cost effective and sophisticated financial advice for more people.
Sourced from Jeremy Taylor, strategy owner, capital markets, GFT