Tölvumál - 01.01.2018, Qupperneq 20

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Robo-advisors1 provide an automated service that proposes an
investment portfolio – usually consisting of stock and bond index funds.
For individuals who wish to use this service, a robo-advisor is as first
step a website where they are asked to enter their risk tolerance and
investment amount. Based on relatively simple algorithms, robo-advisors
then propose a portfolio composition and provide information about this
portfolio’s past annual return and risk, which for this purpose are assumed
to also be the portfolio’s expected return and risk. Investors only have
the choice whether to follow the advice of the robo-advisor (potentially
with minor adjustments) or not. A multi-stage adjustment process with
explicit and more detailed advice on individual portfolio components is
not intended by most robo-advisors. If the investor agrees to follow the
advice, the robo-advisor automatically establishes and rebalances the
proposed portfolio to offset the variations induced by asset price
movements in order to keep the portfolio’s ratio of stocks and bonds
constant over time. This means that beyond providing financial advice
the robo-advisor is connected to an automated portfolio or wealth
management (Oehler/Horn/Wendt 2016).
The robo-advisors’ service is highly standardized. They are therefore
able to offer their service at lower fees for investors than the other financial
advisors. The annual fees of robo-advisors typically range between 0.15
and 1 percent of the assets under management and include all costs
associated with the depot and the rebalancing of the portfolio (e.g., Ferri
2015, Oehler/Horn/Wendt 2016). In addition, the digital format of robo-
advice allows offering this service 24/7, which provides clients with more
flexibility regarding the point in time when to seek advice.
On the flipside, the high degree of standardization ultimately leads to a
limited range of investment tasks that robo-advisors can be used for.
While from an advice-seeking investor’s point of view, robo-advisors are
supposed to support portfolio choice, most robo-advisors hardly consider
the financial products that their clients are already invested in. Portfolio
effects between the robo-advisor’s proposal and financial products that
the client already owns are, therefore, disregarded (Oehler/Horn/Wendt
2018).
Similar to other types of advice, financial advice shall provide useful
information about a set of products. The information needs to be
transparent (allowing investors to inform themselves about relevant
product characteristics), comprehensible (i.e. presented in plain language
without use of technical terms), and comparable among similar or closely
related products. Moreover, the information needs to be unambiguously
clear about essential product characteristics (such as substantial risks,
all costs and charges, liquidity/flexibility, net return, and impact on other
financial products) and indicate which financial needs the product is
adequate for. Last but not least, the information needs to be verifiable
(Oehler/Wendt 2017, Oehler/Horn/Wendt 2017).
So far, robo-advisors do not entirely fulfil these requirements. As
mentioned above, portfolio effects are partially disregarded. In addition,
robo-advisors commonly only provide information about the products
they propose, which means that investors do not receive information
about alternative products. Furthermore, given the simple interaction
mechanism between investor and website, robo-advisors cannot ensure
that their clients perceive and interpret information correctly. Although
this might also be the case when investors consult an individual as
financial advisor, the communication between individuals typically still
allows for more detailed feedback and response and better opportunities
to ask questions. One example of potential misunderstanding relates to
the portfolio rebalancing service. While some investors might be attracted
by the idea that rebalancing keeps the portfolio’s risk exposure close to
the initial level (Tokat/Wicas 2007), it is unclear whether all investors are
aware of the fact that rebalancing in turn usually leads to lower returns
and whether rebalancing actually corresponds to the individual’s
investment goals (Hilliard/Hilliard 2018).
At robo-advisors’ current development level, it is doubtful if all investors
will benefit, although robo-advisors offer a number of advantages. In
exchange for lower fees and high availability of robo-advice, investors
might receive less useful information and they relinquish the opportunity
to detect possible misunderstandings through the feedback from an
individual as financial advisor. On the other hand, investors who are
capable to assess their own financial situation and the characteristics
and portfolio effects of financial products in an appropriate way might
well benefit from the robo-advisors’ service as an inexpensive way to
participate in international asset markets (Oehler/Horn/Wendt 2018).
The tough competition among robo-advisors might lead to rapid
improvement of their service. Some robo-advisors have already
implemented approaches to better assess the investors’ financial situation
with the aim to protect investors from buying risky assets when they
cannot stand a possible financial loss (Oehler/Horn/Wendt 2018). Robo-
advisors can be considered an interesting alternative to traditional financial
ROBO-
ADVISORS:
THE FUTURE
OF
FINANCIAL ADVICE?
Stefan Wendt, Assistant Professor of Finance, Reykjavik University,
Matthias Horn, Department of Finance, Bamberg University
Andreas Oehler, Full Professor and Chair of Finance, Bamberg University
1 Examples for robo-advisors include: Betterment (USA), MoneyFarm (UK), Nutmeg (UK), Quirion (Germany),
Scalable Capital (Germany), Schwab Intelligent Portfolios (USA), Wealthfront (USA).