Technology has brought about various disruptions to traditional business processes and finance is no exception. One of these disruptions has been presented to us in the form of automated investing.
In this article, we will explore the the main values that automated investing can bring to the finance scene that traditional investing options are not able to.
What Is Automated Investing
Automated investing refers to the use of algorithms (formulas) to manage and allocate the assets in investor’s portfolios. It is also known as robo-advisory. The main point is that the use of these algorithms would cut out the need for financial advisors to manage your portfolio. The cutting out of financial advisors would reduce labour costs and therefore the costs for investors to manage their portfolios.
This could be a good or a bad thing depending on the financial situation of your portfolio as we shall see below.
Here are 3 important differences to take away from automated investing:
Different Methods of Risk Assessment of Investors
Automated services would assess the risk of investors a lot more differently (and more vaguely) than the usual financial advisor. This is important because if your risk profile (your risk appetite) is not assessed thoroughly, the robo advisors could be making an investment decision that could be potentially detrimental to the health of your portfolio in the long term.
This is because robo-advisors tend to simplify information and reduce these preferences down to figures while excluding factors that cannot be reduced to numbers (e.g. our personal preferences when it comes to investing). This is opposed to traditional financial advisors who are able to take into consideration qualitative factors that cannot be quantified when constructing an advice for investor’s portfolios.
Let’s use an example, on one of the more popular automated investment companies, you would be asked to key in your age and your annual income which are the criterias used to estimate the combination of stocks and bonds that suits you. Using this criteria, the robo-advisor generated the combination of stocks and bonds for a “safety net” option which were the same for a 23 year old earning $30,000 annually as with a 60 year old earning $12,000 annually.
This illustrates the potential black and white option for investors when using automated investing as opposed to more personalized options when managing your portfolio via financial advisors.
The main argument for automated investing is that it reduces the overall costs of managing your portfolio because financial advisors are cut out of the process and therefore, investors would not be paying them to manage their portfolios. This could be good because it could also mean that services that do not add value to your portfolio would be automated instead of being done by human financial advisors and you would be able to cut out fees for such services.
However, this assumption that automating certain services would result in lower costs is not always necessarily true. In fact, it could be the reverse. This can be illustrated from the example above where companies use relatively simple criterias to assess the risk of investors. If a retiree were to pick an option with a higher proportion of stocks (riskier than bonds) than bonds and perhaps not know the difference between the two, the retiree is at risk of losing more money instead of saving it!
Human Side of Management Cut Out
As previously mentioned, financial advisors would generally be absent from firms offering automated investment services. However is this necessarily a good thing? Automation could be beneficial for static processes like analyzing your financial situation.
Therefore, it would be more suitable for investors who have relatively lower interest in being involved in the process of investing their capital or have basic needs when managing their portfolios. This could work better for managing smaller portfolios where choices are generally limited.
When managing portfolios with larger amounts, the human element is needed because it is more likely that complexities would be involved in such portfolios as the unique financial preferences of these individual investors.
Due to this reason, some companies such as Vanguard still employ financial advisors while offering automated services because they understand that there are still some processes that are beyond the scope of what machines can handle.
Automated investing is starting to kick off in Singapore with various platforms starting to sprout such as Bambu, Smartly and Infinity Partners among others. With this service starting to take root here, investors should be aware that only certain processes that are mechanical and does not add value to your portfolio (e.g.housekeeping process) can be automated.
At the same time, these services should still be coupled with human financial advisors for those processes that has a variable element in it to optimise the management of investor’s portfolios. In this case, technological disruption would perhaps reduce the number of financial advisors but not entirely eliminate them.
Bonds and Fixed Income