Robo advisory not for everyone, works best for investors with small capital

As income and responsibilities increase, financial planning gets more complex and needs regular human intervention

A click of the button is all it takes to access online financial planning websites or robo advisory platforms. But if you are looking to draw up a detailed financial plan for the future, you may still need a financial expert.

As online shopping becomes the buzzword, many investors are bypassing traditional financial planners and switching to online investmenting. This, however, cannot be equated with buying clothes online. Investments are meant to safeguard your finances over the long term and require in-depth planning. Unless the investor comes armed with strong financial knowledge and has enough time to manage his financial portfolio, online investing may not give him the same satisfaction that online shopping does.

There are many models of robo advisory. Some only suggest mutual funds or stocks for your goals and horizons. A few also make a financial plan and then advise individuals on where and how to invest.

Online financial planning is cheaper: An investor visiting a robo advisory platform is asked to answer a set of questions to determine his risk profile, goals and time horizon. Algorithms work on the answers and suggest age-appropriate asset allocation, minimising or negating the need for human intervention.

A robo advisor may seem like the perfect solution for those with only a small investment capital who are just starting their investment journey, but it may not be suitable for long-term financial plans. As income and responsibilities increase, financial planning gets complex and requires constant intervention that can be provided by a human financial advisor only. He will come up with a holistic long-term financial plan that accounts for the investor’s future needs and emergencies, and will chalk out a road map for achieving future goals.

Online investing is cheaper in the absence of distributor’s fees and other marketing expenses, resulting in higher returns for the investor. A financial planner charges Rs 15,000-40,000 a year to manage a client's finances. Wealth management companies, which cater to the wealthy, charge 0.75-1.5 per cent annually of the assets under management (AUM).

The charge for a robo advisor could vary from Rs 1,000 a year to Rs 7,500. A few only work on the commissions they get from fund houses or insurers and the client does not pay anything.

Robo advisory platforms have their flaws: The positive aspect of robo advisory is that it takes away human biases from investments. As robo advisory platforms are driven by technology, they allow investors to automate many aspects of investment and financial planning, set alerts, get instant reports, and so on. Investors are also not subjected to mis-selling of financial products. While these platforms are free of human biases, the algorithms driving them need to be evaluated continuously and updated to suit the current investment environment.

Good investment advice is recommending the right fund to an individual based on his goals and risk appetite. To be able to take an informed decision, investors need to be aware of downside risks. Without detailed explanations on the recommended product, the investor may well be locking his money in an investment where he doesn’t know what to expect. A case in point is credit risk funds, where investors parked funds based on high historical returns, without understanding the associated risks. When these funds were hit by credit defaults and their net asset values (NAV) dropped, investors were unprepared and pressed the panic button. It is the same with equity systematic investment plans (SIP). Investors believe that SIPs give linear returns and tend to exit or stop investing once they see negative returns.

In several instances, online investors were advised to invest in balanced funds for a tenure as low as three years, though equity requires an investment horizon of at least five-seven years. Over the long-term, the volatility of returns reduces and average returns increase in equities.

An investor’s best defence against mis-selling is his financial knowledge, which will help him ask the right questions and take informed decisions. For instance, investors who understand the basic difference between equity markets, which are more volatile than debt, know that the former is suitable for longer-term investments while the latter is suitable for shorter-term investments. 

An advisor is essential when things go wrong: Even as investors might get reminders regarding payments, changes to the portfolio, etc, they alone are responsible for being regular with their investments and following the suggested investment plan. Online investment platforms and robo-advisors cannot assess irrational decisions like selling during a downturn and buying in a bullish market. A human advisor, on the other hand, would understand the nuances governing those irrational judgments and with persistent intervention, even be able to persuade the investor to invest for a longer term.

In developed markets, hybrid robo advisors are becoming popular. This is because, over a period of time they have realised that customers need to talk to someone. Most robo advisors there now provide financial advisory services over the phone or via video chat as well for a fee that is based on the size of the customer’s portfolio.

Given the low penetration level of financial products in India even among the educated, both robo advisors and human advisors can co-exist and are required. Since investment decisions are 80 per cent based on an investor’s behaviour and 20 per cent based on a product, a robo platform will provide transactional convenience. In the long term, however, human advisors can help keep investors on the right path in their investment journey.

Not a complete investment solution

Advantages

• Costs are low

• Free of human bias

• Can reach far-flung areas and small towns

• Technology enables alerts and better reporting

Disadvantages

• Algorithm may not work unless updated regularly

• It could recommend unsuitable funds

• May not work well as the portfolio size swells 

• Cannot handhold investors during downturns

The writer is founder, Finsafe India