Robot
The future is here, and it includes robots managing your money.
Or, to be precise, robo-advisers: Programs that use an algorithm to help you determine what investments are best for you.
The thought of putting a computer in charge of your financial decisions may make some uneasy, but if you do your banking online, as well as buy groceries and set up dates, why not also receive financial advice over the Internet?
That appears to be the thinking behind a field garnering a lot of interest in the U.S., and one which the president of the Investor Education Fund in Toronto says reflects the fact that younger generations are changing the way they interact with every market place.
"It's natural to think that this may be a solution that works for them, because they're not coming to the market place with pre-conceived notions," said Tom Hamza.
"There may (also) be some skepticism lingering from major financial events that have happened in the last decade or so."
The robo-advisers take you through a series of questions to determine your goals and your risk tolerance and then build a diversified portfolio using passive investments like index funds and ETFs.
The automated financial advice is generated by software programs developed by specialized wealth management firms that take your information and run it through their calculators. Some rely solely on algorithms, others involve an online advisor or are a combination of both.
"These organizations can provide advice to clients at a very low price point, and they can serve a portion of the population that's been really under served, people who haven't had access to investment advice," said Robert Stammers, director of investor education at the CFA Institute.
Robo-advisers are also generating buzz in Canada, although the concept has yet to be fully established here. Some Canadian brokerages are offering more online advisor services, but the U.S. has several small, quickly growing robo-adviser companies serving investors.
Wealthfront Inc., one of the biggest with more than $800 million in client assets, doesn't charge an advisory fee on the first $10,000 of assets under management. On amounts over $10,000, the monthly advisory fee is based on an annual fee rate of 0.25 per cent. Clients also incur the fee embedded in the cost of the ETFs owned, which averages about 0.17 per cent. Betterment, its biggest competitor, offers a management fee as low as 0.15 per cent, so both are below the roughly two per cent most traditional financial advisors charge.
But while financial experts think Canadian markets would benefit from a bigger robo-adviser presence, they also warn this new alternative doesn't come without risks.
There are questions around whether the software is sophisticated enough to asses a client's tolerance for risk and to adapt with changing markets, or to deal with investments that may become more sophisticated.
It's also unclear whether the tools these programs used to gather information are the most effective. A 10-question questionnaire about your risk tolerance and goals may not give the complete picture - and investors aren't always the best at assessing their own capacity for risk.
"It's easier for an algorithm to determine someone's financial ability to take risk, but it's a whole lot more difficult to determine a client's emotional ability to take risks, and that's probably where a financial advisor has an advantage over a computer," said Stammers.
It may also be difficult for people to compare across these platforms because, as they are based on computer code, their inner workings aren't always clear.
Adam Molnar, a surveillance expert with Queen's University, said investors should also think about the security of their private information when looking to use this kind of software.
The exposure of the Heartbleed security bug that prompted the Canada Revenue Agency to shut down its website last month, he said, shows that "there is no such thing as perfect security."
While most companies will promise to take security seriously, customers can't independently gauge whether that's the case. They should really think about the kind of personal information they're putting up that risks being acquired and sold on the black market, he said.
"The issue is not that they're huge trades," said Molnar. "They're high volume, low margin trades in this kind of software. It's not so much about directing the money, it's about gaining stolen credentials that can be used in other parts of the Internet."
But if you can make the robo-adviser model work (and work safety) Hamza says, these "couch potato of portfolios" could be a great addition to the financial services industry because they would ensure your portfolio is diversified.
They would also take the focus away from day-to-day movement of stocks, a habit investors don't necessarily benefit from but find difficult to break.
"The whole perspective of these robo-advisers is that you're really focusing on the forest on not focusing on the trees," Hamza said.
"It takes the conversation away from buying and selling this stock and it takes it away from the day-to-day looking at investments and tends to take a much bigger asset class viewpoint."