Wealth-management opportunities open up to people with smaller amounts to invest.

Robo-advice has been used in the United States and Europe since around the time of the 2008-09 Global Financial Crisis and has cemented its position in Australia’s wealth-management landscape. 

Robo-advice automates many of the time-consuming processes involved in managing investments. This means its services are generally low-cost and can generate more consistent outcomes for investors.

How it works

Most robo-advisers use exchange-traded funds (ETFs) to build portfolios that are diversified across various asset classes and geographies to suit your risk profile and investment horizon, which are assessed using an online questionnaire. 

Once you have opened an account and deposited money, the robo-adviser moves from offering advice to actual management, buying ETFs in proportions that correspond with the risk profile you have accepted. 

Your portfolio will be periodically rebalanced so that, as certain holdings rise or fall in value, your investments stay on track with your target asset allocation. Any new money you add will be allocated in the same way.

Lower costs for investors mean more funds are invested and benefit from the power of compounding interest. 

Robo-advisers are also opening up the world of investment to people with much smaller investment amounts. A traditional financial adviser might only find it economically viable to meet clients with $500,000 or more to invest, whereas most robo-advisers can offer their services for investments of $5,000 or even less, in some cases.

Who robo-advice suits

Many kinds of investors are using robo-advice in Australia, including:

• New investors who do not have the experience to manage a portfolio
• Time-poor investors
• Self-managed super fund trustees seeking affordable investment diversification
• Parents or grandparents investing for loved ones
• Active investors (those who typically buy and sell individual stocks) who also want a more passive, diversified, risk-adjusted base to complement the more speculative aspect of their investing. This is sometimes called “core-satellite” or “hub-spoke” investing.

Most people using robo-advice have a medium to long-term investment horizon. Robo-advice is best for people who have cash they want to invest in a smart, low-cost, low-hassle kind of way. It typically involves “scaled personal advice” – which means the advice is relevant only for the funds you put on the service’s platform. 

Robo-advice is also increasingly used by financial advisers and wealth-management firms to help them effectively and cost-efficiently service a larger client base. 

Benefits of robo-advice

Robo-advice is accessible, affordable, and combines the proven investment tenets of diversification and low fees as drivers of long-term growth. This is particularly relevant as there is now a robust body of data that suggests active fund managers typically underperform their benchmark indices.

Robo-advice can save investors significant time and stress by providing a combination of professional oversight and the automation of portfolio rebalancing (an important part of investment management that has been proven to improve long-term outcomes). 

Investors can easily update their risk profile or time horizon if their personal situation changes, and most robo-advisers are transparent in their approach to fees, performance and any relationships with third parties, avoiding the kinds of conflict of interest that were exposed frequently during the Banking Royal Commission. 

Robo-advice services use technology to reduce costs, so one of its key benefits is harnessing the power of compounding interest over time. 

It is not about timing the market, as a slew of mum-and-dad investors have tried to do during the COVID-19 pandemic, sparking warnings from ASIC and the Reserve Bank. Rather, it is about “time in the market” and generating strong risk-adjusted returns over the medium to long term.

Potential risks

Not all robo-advisers are created equal. Like any financial decision, do your research before choosing a service to manage your money.

All robo-advice services need to have some degree of “people power” behind them, but the best and most trustworthy services are backed by people with proven investment experience. 

Importantly, while the robo-advice platform needs people who are tech-savvy to manage the security of the business, important investment decisions such as asset allocations should be trusted to people with a long and successful track record in this area. 

Asset allocations need to be professionally assessed and reviewed, but not all robo-advisers offer this level of service, so check whether the service you are considering has a human overlay of experienced people assessing the investments.

Some robo-advisers will pool your investment with other clients’ money; others keep investments separate by setting up each client with a cash-management account and trading account in their own name. 

This process might add a couple of steps but there are pros and cons to each method. If a robo-adviser did cease trading, a HIN (Holder Identification Number) model means everything is clearly defined in your name. It is worth determining which investment model the robo-adviser uses.

Where robo-advice is headed

Overseas, the Global Financial Crisis drove awareness of the need for a better way to get investment advice, in much the way the Banking Royal Commission has illuminated the same dynamic in Australia. 

Additionally, the convergence of technology-led services and the growth in Australia’s ETF market has accelerated the growth of credible, tested services. The lack of access to affordable professional advice and many investors’ lack of investment diversification have also been wind behind the sails of robo-advice in Australia.

Lastly, the COVID-19 pandemic has brought into further, sharp relief the fact that the mass market desperately needs help with investment management. A high level of day trading among retail investors, many without proper experience, has been an alarming trend.

Where to from here?  After much fanfare (based on US precedent) but modest broad-based growth in the past several years, we expect robo-advice to grow rapidly in Australia, and to also see increasing alignment between robo-advice services and incumbent wealth managers, banks and others that serve the mass market, as this has been the precedent overseas. 

This is how the mass market will be best served, as the combination of existing robo-advice services work collaboratively with entities that have deep consumer reach to get this much needed service to more people.