Robo-advisors are automated digital investment platforms, driven by algorithms to provide you with financial planning services
Before you decide whether to choose between a financial advisor or a robo-advisor, you must know the main difference between the two. Robo-advisors are automated digital investment platforms, driven by algorithms to provide you with financial planning services. They charge much less than human financial advisors would (or don’t charge at all), because they need minimal supervision to function. However, cost should not the main criteria for your decision.
Since robo-advisors use algorithms to help you plan your asset allocation strategy, they are dependent on the information you are going to put in. Any model portfolio or a generic one-size-fits-all model does not work in the long run. So, knowing what data needs to be entered requires experience, which is where the robo-advisor model may fall short. Having said that, robo-advisors use machine learning, so they will evolve into more intelligent and trustworthy services over time, with more usage.
Rob-advisors are not equipped to handle specific emotional needs or situations that might arise in the lives of investors. Neither can they provide the hand holding that a human financial advisor can provide during distress. Additionally, they may not be equipped to understand your relationship with money. Investing is more behaviour than science.
For instance, how do you react when you see your stock or mutual funds portfolio turning red, i.e. giving negative returns, in case of a market correction? Even though investors may be aware that this is an inherent short-term pattern, they often press the panic button and take irrational decisions. Or what do you do when you have some some spare money? Will you increase your investments or prefer to spend it? More often than not, people end up using that windfall or surplus money for spending, rather than for long-term planning.
A person who started out investing in stock markets directly or via mutual funds only in the past year or so may not have made any money due to an overall negative trend, especially in the mid-cap and small segment. Many of those investors have started thinking that rather than investing in mutual funds or equity, they could have been better off investing in a fixed deposit, isn’t it? But always remember that comparing fixed deposit to equity investment is not an apple to apple comparison. So, you need to watch out your investing behaviour, patterns and how your emotions can drive you, get an assessment of your emotional profile, apart from risk profiling.
Robo-advisers rely on artificial intelligence, and will take some time to acquire knowledge of human behaviour patterns. So, if you are going to employ a robo-advisor, you need to have your math right. If your financial priorities, goals, and needs are perfectly clear to you, then a robo-advisor can be of great help in devising your asset allocation strategy.
The lower fee structure and ease of use of robo-advisory are key factors that make it suitable for millennials. It is a great way for those starting out their investment journey and can work wonders for them due to its ease of use. Keeping in mind the conditions specified and some careful planning, going with a robo-advisor can be an excellent tool to manage your money.
The author is a Chartered Accountant by Profession and a founder and Chief Gardener of Money Plant Consultancy.