What is a robo advisor?
Robo-advisors, though not an entirely new concept, have become mainstream in the online investment community. The COVID-19 pandemic has pushed every sector to its limit and forced it to continue operations with limited physical interactions.
Robo Advisory has made a significant impact in the wealth management sector with its reputation as an efficient and low-cost investment management solution. The market size was valued at $4.51 billion in 2020 and is expected to reach $54.15 billion by 2028, growing at a CAGR of 31.84% from 2021 to 2028.
Efficient and low-cost solution
Robo advisors are digital investing platforms that offer retail investors an affordable and automated investing service, using technology and algorithms to manage investments with little to no human intervention.
Robo advisors help investors distribute their money across stocks while keeping the investors’ risk preferences in consideration. In most cases, you’ll be asked questions about yourself and your investment goals via an app. This helps the robo advisors to also calculate monthly deposits based on your goals, assess your net worth and take advantage of advanced tax strategies.
This year in the UK, over 420,000 adults are expected to use a robo-advisor to handle their investments, up by 25.2% over last year. This growth follows the 55.6% growth in 2020. The number of robo-advisor users is on pace to reach about 700,000 in the UK by 2025.
Emerging in the wake of the Great Recession
Human wealth managers have been using automated portfolio allocation software since the early 2000s, but it wasn’t available to the average investor until 2008. The early robo advisors acted as online interfaces for managing and balancing clients’ assets.
It wasn’t until the 2008-09 financial recession that the robo advisory services became widespread. The popularity could be attributed to the traditional financial institutions that found it challenging to maintain their clients’ wealth due to negative sentiment in the market and falling interest rates.
Taking advantage of the sentiment and the low market penetration, companies such as Betterment and Wealthfront began encouraging investors to invest in algorithm-driven portfolios for getting steady returns.
In 2011, online investment provider Nutmeg introduced its first robo advisory service and hit the direct-to-consumer discretionary service scene in the UK.
Modern robo advisors have entirely upped their game with optimised portfolios for socially responsible investing, Halal investing, embedded investing and more. In addition, robo advisors can now handle sophisticated tasks, including your tax-loss harvesting and retirement plans.
Benefits
Selecting a robo advisor for your or your clients’ investment management needs can have a host of benefits -
- Robo advisors are low-cost alternatives to traditional advisors. They are online platforms that offer similar services as financial advisors but without the cost of manual labour.
- They are relatively easier to use and accessible. All you need is an internet connection! Robo advisors are designed to be straightforward, and they provide full access to portfolio management tools, which offer more flexibility and security to users.
- Robo advisors offer comprehensive services such as retirement planning, tax-strategy schemes, and portfolio rebalancing. The robo advisor can also manage your portfolio, ensure you’re on track to reach your investment goals and minimise any liabilities on a single platform.
Future of robo advisors
So does Robo advising have the potential to drastically change the investment landscape? Given the current scenario, the sector faces two biggest challenges -
- They cannot offer customised services that a human advisor can. Human advisers have the capability to suggest long term investment solutions and avoid bad investments, while robo advisers simply automate decisions based on your basic information and investment goals. Though it isn’t likely to be a challenge for long as AI has been making drastic advancements every week and is becoming increasingly capable of handling complex transactions and planning.
- Robo advisors are considered untrustworthy by some because of the uncertainty in the market towards automated machines making important decisions. But with the rise of automation, people are likely to see the other side of the coin and realise the benefits of robo advisors.
There is research indicating that younger people, in general, are more likely to be open to using automated technology for handling investments. A survey performed by fund management company Global X that nearly 1 in 5 millennials are comfortable investing with robo advisors. This figure compares to just 1 in 10 of Gen X’ers and 1 in 30 Baby Boomers.
This proves that a shift in demographics to a more technology-friendly generation is likely to resolve the lack of trust.
Fully automated robo advisors are on the rise and their emergence might help to cut down costs related to manual labour, operating expenses and capital expenditure due to the complete digitalisation of financial advisory services.
The market is also witnessing a rise in hybrid robo advisors that intend to combine the best of both worlds. A hybrid robo advisor is a service that typically combines a professionally managed account (through the help of a robo advisory service) with access to financial guidance or planning provided by human advisors.
The COVID-19 crisis
More than a decade since its inception, the robo advisor market is witnessing a changing investor mindset brought about by the COVID-19 crisis.
The sector saw significant growth during the pandemic with an average rise of 3.1% in accounts. The reason for this likely lies in the downsizing of equity prices leading to a bear market - a favourite place for bargain hunters.
The future (post-pandemic) looks promising for the hybrid robo advisor market. But the underdeveloped capital market and its data handling systems and regulatory regimes remain as the only challenge for robo advisors.
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