1.5.2 Robo-advisors

Introduction

In recent years, a new online investment service has emerged that provides clients with advice, contrasting the execution-only model of self-directed brokerage. Popularly known as robo-advisors, these firms began to appear in the United States after the 2008 financial crisis and grew rapidly through the 2010s. In Canada, online investment advice platforms began to proliferate in the mid-2010s, with multiple service providers registered across several provinces.

Robo-advisors are now an established channel for delivering diversified, low-cost portfolios (often ETF-based) using a combination of algorithms and human oversight. In Canada, robo-advisor services are offered through firms registered with provincial/territorial securities regulators and are subject to key investor protection requirements (such as KYC, suitability, and disclosure).

Key Features of Robo-Advisors

Robo-advisors offer several core features that distinguish them from traditional investment services. Many variations exist, but most share several of the following attributes:

Goal-Based Online Investment Management

Robo-advisors provide clients with goal-based online investment management. This involves creating customized portfolios to meet specific financial goals such as retirement, education, or major purchases.

Algorithm-Driven Portfolios

Portfolios are created using algorithms based on modern portfolio theory and client responses from online questionnaires. These algorithms assess factors such as risk tolerance, investment horizon, and financial goals.

Advisor Verification

A workforce of advisors verifies that the computer-generated portfolio is suitable for the client through a phone call or online consultation.

Support and Accessibility

Support from human advisors is offered to varying degrees, typically through online chat or phone services.

Exchange-Traded Funds (ETFs)

Portfolios are primarily built using exchange-traded funds (ETFs), offering liquidity, diversification, and often lower costs compared to individual stocks or mutual funds.

Regular Rebalancing

Portfolios are regularly rebalanced to maintain the original asset allocation and ensure alignment with investment goals.

Financial Planning

Financial planning may be incorporated to various extents, helping clients with broader financial goals beyond mere investments.

Service Provision

Services may cater to end clients as well as intermediaries such as other advisors and employers.

Client Experience

Competitive positioning is based on the overall client experience, which typically includes:

• Ease of online navigation
• Speed of account opening and transfers
• Integration of service delivery across devices
• Transparency of performance and fees

Tax-Efficient Management

Portfolios are optimized with tools such as tax-efficient rebalancing across different account types.

Key Takeaways

• Robo-advisors offer a modern alternative to traditional investment management, leveraging technology to provide cost-effective, goal-based financial advice.
• They have become significantly impactful in the investment landscape, particularly in the United States and Canada, with substantial assets under management.
• Algorithm-driven methodologies and ETFs are central to their ability to provide efficient portfolio management and regular rebalancing.
• The integration of human advisor support ensures that while the service remains technologically advanced, it also caters to personal financial needs.
• They enhance the client experience with user-friendly interfaces, transparent processes, and tax-aware strategies.

Frequently Asked Questions (FAQs)

What is a robo-advisor?

A robo-advisor is an online platform that provides automated, goal-based investment management and financial advice, often using algorithms.

How do robo-advisors create portfolios?

Portfolios are created using complex algorithms based on modern portfolio theory and client data gathered from online questionnaires.

Are human advisors involved?

Yes, human advisors typically verify the suitability of the algorithm-generated portfolios and provide support through phone or online communications.

What types of investments do robo-advisors use?

Robo-advisors primarily use exchange-traded funds (ETFs) to build diversified, cost-effective portfolios.

Are robo-advisors only for individual investors?

No, robo-advisors also provide services to intermediaries such as financial advisors and employers.

Glossary

• Robo-Advisor: An online platform that provides automated investment management and financial advice using algorithms.
• Modern Portfolio Theory: An investment theory focusing on maximizing return for a given amount of risk through careful asset allocation.
• Exchange-Traded Funds (ETFs): Investment funds traded on stock exchanges, holding a diversified portfolio of assets.
• Rebalancing: The process of realigning the weightings of a portfolio’s assets to maintain the desired risk/return profile.

Charts and Diagrams

Example Workflow of a Robo-Advisor

    graph TD
	A[Client completes online questionnaire] --> B[Algorithm creates initial portfolio]
	B --> C[Human advisor reviews portfolio]
	C --> D[Client approves and funds account]
	D --> E[Portfolio is monitored and rebalanced regularly]