Affordable financial planning: robo-advisors and automated money management
Who can afford a financial advisor? Not me, most people think. And for good reason. The financial planning industry has a reputation for being expensive, confusing and not 100% trustworthy. But all of that is changing with robo-advisors and Exchange-Traded Funds (ETFs). Technology is making money management and financial advice accessible for everyone.
The Banking Royal Commission told us what we already suspected
It’s Friday 1st of February 2019 and Commissioner Kenneth Hayne, a High Court Judge of Australia, is submitting his ‘Final Report of the Royal Commission into Misconduct in the Banking, Superannuation and Financial Services Industry.’ He looks stony-faced as he hands over the 496-page document to Josh Frydenberg, the Federal Treasurer.
There’s good reason for Hayne’s grim demeanour. His investigation has uncovered a toxic culture of profit-chasing in the banks. Payment practices that encourage unethical behaviour. Poor transparency. Lack of accountability. Fees for no service. Non-compliant advice.
The report outlines 76 recommendations to better protect customers. Later, the Australian Securities and Investment Commission (ASIC) finds ANZ, AMP, Macquarie, CBA, Westpac and NAB responsible for more than $3 billion in reparation payments to customers.
That’s not to say that all financial advisors are shady. On the contrary, the vast majority of financial planners in Australia work independently or in smaller firms. They are highly qualified, ethical, professional and customer focused.
Still, for many people, the Banking Royal Commission confirmed what they already felt they knew: financial planning is not for me. Financial advisors have high fees I can’t afford. I don’t have enough money to invest. The products are too complicated. The investments are too risky. The fine print is too scary.
Financial planning gets a tech makeover
Financial planning–and banking in general–has been an industry begging for disruption. Look back 20 years and you’ll see that the foundations for a revolution were already forming. Since the 2000s, investment managers have been using automated portfolio management software. Not to mention that online banking was–and continues to be–quickly adopted.
And then artificial intelligence (AI) arrived on the scene. AI describes computing systems that can perform human-like work. Siri, Alexa and other smart assistants are just one type of AI. When Spotify predicts which songs you’ll like, that is another. Add to the AI list: self-driving cars, robotic devices, maps and navigation, facial detection, chatbots, and so on.
Not surprisingly, it turns out that computers are often better than humans at making financial decisions. What an algorithm lacks in personality, it can make up for in information interpretation. Computers can analyse millions of data points quickly. They have no emotional or cognitive biases. And they don’t stop for food, sleep or water cooler gossip.
In the last decade, sophisticated investment algorithms have grown into what we call ‘robo-advisors.’ These are software-driven, digital platforms that can create and automate tailored investment portfolios around an investor’s goals and financial situation.
There are, of course, limitations. A robo-advisor may not be able to spot the “next big thing”, overhear stock tips, meet with you face-to-face, take you to lunch or provide tax planning advice (yet). But they have proven to be comparatively reliable at delivering solid returns with small risks at low cost.
Robo-advisors work like this
How does the robo-advisor formulate investment advice?
Using information you provide about your financial goals, risk appetite, how much you want to invest and how often, the robo-advisor recommends an investment strategy and sets up an automated investment plan.
How much do you need to start investing?
Instead of needing thousands of dollars, investors can begin with as little as $1, depending on the provider. The key principle of robo-investing is that you set up recurring daily, weekly or monthly investment amounts. You can also add lump sums and, in some cases, automatically invest spare change (“round-ups”) from your purchases.
How much does robo-investing cost?
Rather than paying brokerage or transaction fees, there is usually a small annual or monthly fee for using the service. Depending on the provider, this may be a flat-fee or a percentage of your investment balance.
Who is using robo-advisors?
In the United States, the robo-advisor segment is growing at nearly 15% a year and the average account balance is just over $5000 USD. Let’s remember that in Australia, most people are already investors via superannuation. Super offers significant tax advantages, including the option to save for your first home deposit inside your super fund or to make concessional contributions. Tax planning is one key area where a robo-advisor can’t replace the advice of an accountant or human financial planner.
What is the risk of robo-investing?
The typical robo-advisor investment strategy emphasises diversification. Rather than investing in individual stocks, robo-advisors typically invest in (ETFs). ETFs are a bunch of different stocks bundled together into a trading instrument you can buy and sell on the stock exchange. There are still risks. ETFs are tied to the share market which means your portfolio value may go up or down. Diversification helps to spread and reduce the risk.
How do you decide which ETFs to invest in?
You don’t. Based on your goals and other information, the robo-advisor manages your portfolio for you.
Robo-advisors in Australia
There are now hundreds of these automated investment management services around the globe. Some of the best known robo-advisors in Australia, include:
They each have subtle differences, so make sure you do your homework. When you compare pricing, features and performance, you may also like to compare how the different apps look and feel.
Financial planning that comes before financial planning
Robo-advisors overcome the major obstacles associated with traditional financial planning. They are designed to be lower cost, lower risk, simpler, more transparent and accessible.
I also like that they turn investing into a habit. As we prove with money management automation at MyBudget, the more you automate your finances, the better chance you have of achieving your goals.
But there’s still one hurdle that many would-be investors face and that’s how to free up spare cash. That’s where we need to talk about the financial planning that comes before financial planning.
For a start, I would recommend asking yourself:
- Have you paid off all of your high-interest debts?
- Do you have at least three months of income in the bank account to cover unexpected expenses?
- Why do you want to invest?
- What are your long and short-term goals and what is the quickest way to achieve them?
As a rule of thumb, pay off your debts before you start saving–especially credit card debt and personal loans. If you have a mortgage, use an offset or redraw facility to offset your savings against your mortgage balance. And then save up a three-month emergency fund to give you security and peace of mind.
With these foundations in place, if you feel like you’re ready to start investing, make sure you talk with an accountant or speak with a free advisor at your superannuation fund. They can explain, for example, the pros and cons of topping up your super versus investing in ETFs.
Automate your money management
If you like the idea of robo-investing, you’ll also be excited to know that you can also automate budgeting and everyday money management. With MyBudget, you can put your bills, expenses and savings on ‘set and forget’, all paid directly from your budget.
Our intelligent system sees your future bills and goals and organises your income into streams. By the time a bill or expense event arrives, the money is already waiting. Every dollar is accounted for and given a job. This means that debt is paid off faster and goals are achieved more quickly.
Think of it this way–whereas a bank statement shows what you spent in the past, MyBudget provides a detailed picture of your future. When you make a change to your budget, you instantly see how it affects tomorrow, next week, next month, next year.
In this regard, your budget is a smart, flexible, ‘in action’ money plan for how you want your life to turn out. And that, I think you would agree, is the most important and exciting financial plan of all!