Browse Canadian Investment Marketplace

1.5.2 Robo-advisors

An in-depth exploration of robo-advisors, their emergence in the investment landscape, particularly in the United States and Canada, their key features, benefits, and impact on the financial industry.

Introduction

In recent years, a new online investment service has emerged that provides clients with advice, contrasting the execution-only model of self-directed brokerage. Popularly known as robo-advisors, these firms began to appear in the United States after the 2008 financial crisis but did not gain significant traction until 2012. By 2019, they had amassed more than US$700 billion in assets under management. In Canada, online investment advice platforms began to proliferate in 2014, with multiple service providers registered in several provinces by mid-2016. Robo-advisors in Canada currently hold more than US$8 billion in assets under management.

Key Features of Robo-Advisors

Robo-advisors offer several core features that distinguish them from traditional investment services. Many variations exist, but most share several of the following attributes:

Goal-Based Online Investment Management

Robo-advisors provide clients with goal-based online investment management. This involves creating customized portfolios to meet specific financial goals such as retirement, education, or major purchases.

Algorithm-Driven Portfolios

Portfolios are created using algorithms based on modern portfolio theory and client responses from online questionnaires. These algorithms assess factors such as risk tolerance, investment horizon, and financial goals.

Advisor Verification

A workforce of advisors verifies that the computer-generated portfolio is suitable for the client through a phone call or online consultation.

Support and Accessibility

Support from human advisors is offered to varying degrees, typically through online chat or phone services.

Exchange-Traded Funds (ETFs)

Portfolios are primarily built using exchange-traded funds (ETFs), offering liquidity, diversification, and often lower costs compared to individual stocks or mutual funds.

Regular Rebalancing

Portfolios are regularly rebalanced to maintain the original asset allocation and ensure alignment with investment goals.

Financial Planning

Financial planning may be incorporated to various extents, helping clients with broader financial goals beyond mere investments.

Service Provision

Services may cater to end clients as well as intermediaries such as other advisors and employers.

Client Experience

Competitive positioning is based on the overall client experience, which typically includes:

  • Ease of online navigation
  • Speed of account opening and transfers
  • Integration of service delivery across devices
  • Transparency of performance and fees

Tax-Efficient Management

Portfolios are optimized with tools such as tax-efficient rebalancing across different account types.

Key Takeaways

  • Robo-advisors offer a modern alternative to traditional investment management, leveraging technology to provide cost-effective, goal-based financial advice.
  • They have become significantly impactful in the investment landscape, particularly in the United States and Canada, with substantial assets under management.
  • Algorithm-driven methodologies and ETFs are central to their ability to provide efficient portfolio management and regular rebalancing.
  • The integration of human advisor support ensures that while the service remains technologically advanced, it also caters to personal financial needs.
  • They enhance the client experience with user-friendly interfaces, transparent processes, and tax-aware strategies.

Frequently Asked Questions (FAQs)

What is a robo-advisor?

A robo-advisor is an online platform that provides automated, goal-based investment management and financial advice, often using algorithms.

How do robo-advisors create portfolios?

Portfolios are created using complex algorithms based on modern portfolio theory and client data gathered from online questionnaires.

Are human advisors involved?

Yes, human advisors typically verify the suitability of the algorithm-generated portfolios and provide support through phone or online communications.

What types of investments do robo-advisors use?

Robo-advisors primarily use exchange-traded funds (ETFs) to build diversified, cost-effective portfolios.

Are robo-advisors only for individual investors?

No, robo-advisors also provide services to intermediaries such as financial advisors and employers.

Glossary

  • Robo-Advisor: An online platform that provides automated investment management and financial advice using algorithms.
  • Modern Portfolio Theory: An investment theory focusing on maximizing return for a given amount of risk through careful asset allocation.
  • Exchange-Traded Funds (ETFs): Investment funds traded on stock exchanges, holding a diversified portfolio of assets.
  • Rebalancing: The process of realigning the weightings of a portfolio’s assets to maintain the desired risk/return profile.

Charts and Diagrams

Example Workflow of a Robo-Advisor

    graph TD
	A[Client completes online questionnaire] --> B[Algorithm creates initial portfolio]
	B --> C[Human advisor reviews portfolio]
	C --> D[Client approves and funds account]
	D --> E[Portfolio is monitored and rebalanced regularly]

CSC® Exams Practice Questions

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Welcome to the Knowledge Checkpoint! You'll find 10 carefully curated CSC exam practice questions designed to reinforce the key concepts covered. These questions will help you gauge your grasp of the material, identify areas that need further review, and ensure you're on the right track towards mastering the content for the Canadian Securities certification exams. Take your time, think critically, and use these quizzes as a tool to enhance your learning journey. 📘✨

Good luck!

## When did robo-advisors start gaining traction in the United States? - [ ] After the 2000 dot-com bubble - [x] After the 2008 financial crisis - [ ] After the 1997 Asian financial crisis - [ ] After the 2010 European debt crisis > **Explanation:** Robo-advisors began appearing in the U.S. after the 2008 financial crisis and gained significant traction starting in 2012. ## What is the primary focus of robo-advisors in terms of service delivery? - [x] Goal-based online investment management - [ ] Manual stock picking - [ ] High-frequency trading - [ ] Corporate advisory services > **Explanation:** Robo-advisors provide clients with goal-based online investment management, typically through the use of algorithms and questionnaires. ## How are portfolios created by robo-advisors typically constructed? - [ ] Using manual stock selections - [ ] Based on client emails - [x] Using algorithms based on modern portfolio theory - [ ] Through random asset allocation > **Explanation:** Robo-advisors use algorithms based on modern portfolio theory and online client questionnaires to construct portfolios. ## What financial instruments do robo-advisors primarily use to build portfolios? - [ ] Mutual funds - [ ] Individual stocks - [x] Exchange-traded funds (ETFs) - [ ] Real estate investment trusts (REITs) > **Explanation:** Portfolios managed by robo-advisors are built primarily with exchange-traded funds (ETFs). ## What role do advisors play in the robo-advisor model? - [ ] They manually rebalance portfolios - [x] They verify portfolio suitability through a telephone call - [ ] They only manage high-net-worth accounts - [ ] They manage transactions manually > **Explanation:** Advisors typically verify that the computer-generated portfolio is suitable for the client through a telephone call. ## Which of the following is NOT a common feature of robo-advisors? - [ ] Regular portfolio rebalancing - [ ] Financial planning - [ ] Advisor support - [x] High-frequency trading > **Explanation:** Common features of robo-advisors include portfolio rebalancing, financial planning, and advisor support, but not high-frequency trading. ## What was the approximate amount of assets under management by robo-advisors in Canada as of the latest data? - [x] More than US$8 billion - [ ] More than US$70 billion - [ ] More than US$700 billion - [ ] More than US$1 trillion > **Explanation:** As of the latest data, robo-advisors in Canada hold more than US$8 billion in assets under management. ## What aspect of competition is critical for robo-advisors? - [ ] In-person client meetings - [ ] High-frequency trading infrastructure - [ ] Large physical branches - [x] Client experience, such as ease of navigation and transparency > **Explanation:** Robo-advisors compete primarily on client experience, including ease of online navigation, speed of account opening, and transparency of performance and fees. ## Which tool is commonly used by robo-advisors to optimize portfolio management? - [ ] Manual stock picking - [ ] Market timing - [ ] Broker recommendations - [x] Tax-efficient rebalancing > **Explanation:** Robo-advisors optimize portfolio management using tools like tax-efficient rebalancing across account types. ## In which year did online investment advice platforms begin to proliferate in Canada? - [ ] 2008 - [ ] 2012 - [x] 2014 - [ ] 2016 > **Explanation:** Online investment advice platforms began to proliferate in Canada in 2014.

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Sunday, July 21, 2024