What is a robo-advisor and how does it manage your money?
The term robo-advisor originated in the US, and has stuck to firms that offer online investment management services. While robo-advisors are able to charge lower fees through the efficient use of technology and by more or less cutting out client relationship managers, they are far from being products that are invested on the whim of a machine. Here we outline what robo-advisors do, and why you can trust them to look after your investments.
Robo-advice has been the subject of many articles in the mainstream press usually accompanied by a photo of complex computer code, or perhaps a robotic hand hovering over a keyboard. Whether designed to inform or alarm, this imagery is unhelpful, as boiled down to basics, robo-advisors are simply online wealth managers that invest their clients’ money in mainstream investments with a goal of generating attractive risk-adjusted returns over time.
All UK robo-advisors have to be authorised by the Financial Conduct Authority (FCA), and they follow the same stringent client money rules that any other financial services firm has to abide by. Client assets are segregated, and legally belong to the clients, while robo-advisor employees must have the relevant qualifications and experience to carry out their investment roles.
They key attraction of online wealth managers is that they are able to deliver a high quality wealth management service at a substantially lower cost than their ‘bricks and mortar’ peers. Through economies of scale, they have opened up wealth management services to a large part of the population who would not be profitable for a conventional wealth manager to maintain a relationship with.
Clients can rest assured that there are people at every step of the process, including 24-hour support from a client services team. For example, IG Smart Portfolios get asset allocation research from a well-resourced team at BlackRock, while at IG there is input from individuals in Legal, Compliance, Corporate Actions, Settlement, IT, Dealing, a Portfolio Management team, and an Investment Committee.
How are costs kept so low?
We don’t claim to speak on behalf of the entire industry, but technology is really able to lower the costs in wealth management by delivering it online. Robo-advisors say goodbye to plush client offices, oil paintings and deep pile carpets, while the pages and pages of confusing application forms and associated data entry have been replaced with a streamlined digital process. Online wealth managers can assess knowledge and experience, risk tolerance and capacity for loss within a few minutes, to offer clients a professionally managed portfolio that, due to the benefits of lower fees, should have a better chance of outperforming the industry peers in the long term.
When it comes to funding a portfolio, IG’s technology enables it to invest client money in exactly the same proportions for everyone, meaning that all accounts will get the same outcome no matter their size. When portfolios are rebalanced, rather than trading every portfolio individually which would traditionally take up hundreds of man hours, alongside the associated risk of making human errors, we can trade every portfolio instantaneously with the click of a button.
What about financial advice and tax?
Tax statements are produced as part of the service, but online wealth managers cannot provide everything. While a discretionary wealth management service has a suitability obligation towards its clients, it does not take into account all of a client’s personal circumstances.
We believe that independent financial advisors (IFAs) and tax advisors still have an important role to play in providing face-to-face advice, and they can add a great amount of value at certain times in your life. At least one of marriage, divorce and inheritance planning will happen to us all and getting your tax affairs in order at these points is important. However there are very large periods of adult life when investing at a low cost, staying the course and allowing your wealth to grow over time will result in a better financial outcome for you.
With a 2017/18 capital gains tax allowance of £11,300, a generous £20,000 ISA contribution and a SIPP threshold of £1 million, the majority of individuals are able to invest well within their annual limits and can be confident that a robo-advisor alone can be their partner in a long-lasting relationship.