Contrary to popular belief, Canadian robo-advisors have little in common with Terminator cyborg killers. In fact, these investment services employ real-life portfolio managers who handle their clients’ money. So there are actually no robots buying or selling on the stock markets.
An age-old model
Portfolio managers working for robo-advisors build several portfolios to accommodate different risk profiles. All robo-advisors will offer a risky portfolio, which is more suitable for young people, and a conservative portfolio, which is more suitable for investors nearing retirement or those who will need their money in the shorter term.
The financial industry hasn’t strayed off the beaten track. So far, it’s still pretty much the same. Full-service brokerage firms, which have been around for a long time, also employ portfolio managers who administer different portfolios tailored to different risk profiles.
However, unlike robo-advisors, full-service brokers use investment advisors, who sell “slices” of their model portfolios to investors through phone calls and face-to-face meetings.
Robo-advisors, on the other hand, don’t sell their model portfolios over the phone and in person. They use their websites to distribute them. Until now, there have not been any new technologies involved except the emergence of the web, which dates back to the 1990s.
In fact, Canadian robo-advisors introduced this innovation to simplify the process of opening an account.
A Canadian investor wishing to open an account with a full-service broker will have to answer a series of questions asked by their investment advisor, which the law requires to make sure they “know their client well”. Only after having taken this regulatory step can the advisor be able to provide advice.
Canadian robo-advisors, for their part, have succeeded in automating this step while complying with Canadian regulations. Rather than answering regulatory questions over the phone, or on a paper form, as they would to open an online brokerage account, their clients answer these questions directly through the robo-advisor’s website.
Once these questions have been answered, the investor sometimes has to wait a few days to be allocated a model portfolio. This delay is due to the fact that in Canada, fully-automated counselling is not permitted.
So, once again, it’s the real portfolio managers who are theoretically responsible for allocating a portfolio to each client. In practice, however, the portfolio managers do little other than call back clients who provided unusual or inconsistent responses in the online questionnaire. Portfolio managers should also be available to answer any questions from investors over the phone.
If you’re a fan of science fiction, I imagine you must be somewhat disappointed to learn that Canadian robo-advisors actually deploy very little high tech. As we’ve seen, their investment strategy doesn’t come from a robot-investor capable of analyzing large volumes of data and predicting the future.
The people who build their portfolios, however, have a common investment strategy: passive investing. In practical terms, this means that the portfolio managers working for Canadian robo-advisors are not trying to beat the stock market, but to obtain a similar return while minimizing costs as much as possible. Their portfolios therefore tend to be comprised primarily of exchange-traded funds (ETFs), which make it possible to invest in a large number of financial products at little cost.
Several Canadian robo-advisors, including Wealthsimple, also argue that they use cutting-edge investment techniques, invented by a Nobel Prize winner (voir version français). That’s true, except that we’re not talking about a new approach, but about techniques that have been part of standard industry practice for decades. This is modern portfolio theory, whose main ideas were espoused in an article published by Harry Markowitz in 1952.
Markowitz won the Nobel Prize, but all financial professionals rely on modern portfolio theory to advise their clients. Basically, modern portfolio theory considers that a portfolio should be constructed to respect the investor’s risk appetite while maximizing its return, based on that level of risk.
This approach has led the industry to build diversified portfolios that evolve with the investor. As a general rule, the closer an investor gets to retirement, the less risk they can afford to take, so the less risky the portfolio. Canadian robo-advisors respect this logic…as financial advisors have (almost) always done.
The difference with American robo-advisors
If you’ve been listening to American podcasts, you’ve probably heard of Wealthfront and Betterment. These are the two most popular American robo-advisors, and unfortunately for us, you can’t invest your money in them without residing in the United States. These robo-advisors live up to their name better than their little cousins in Canada, since they’re truly automated.
Unlike Canadian robo-advisors, American robots are not limited to a predefined number of model portfolios. In a way, they have a single model portfolio, within which the asset allocation can be changed ad infinitum depending on each individual’s risk profile. There is therefore human intervention in the choice of financial securities that make up their portfolio and in the minimum and maximum proportions for each security, but the rest is indeed automated.
By having practically as many different portfolios as there are clients, American robo-advisors would require a whole army of portfolio managers to “maintain” them, that is, to “rebalance”, reinvest dividends, and so on. However, the portfolio management is also automated, although actual human beings have predetermined all the investment strategy’s parameters.
The increased automation of their process, combined with the fact that they have accumulated significantly more assets under management than their Canadian cousins, enable American robo-advisors to offer far lower fees than their Canadian cousins. At Wealthfront, the annual fee is 0.25% on assets under management (excluding ETF management fees) and at Betterment, it’s about 0.15% to 0.35%. This is much lower than what the Canadian robo-advisors charge. For example, at Wealthsimple, the annual fee is up at 0.5% (excluding ETF management fees).
Canadian robo-advisors’ fees
Canadian robo-advisors charge slightly higher fees than their US counterparts. Even so, are their fees prohibitive compared to other means of investing money on the stock market in Canada? The quick answer is no, but let’s take a closer look at their fees. There are three main types.
Unlike discount brokers, robo-advisors charge annual fees that vary depending on the asset under management. By placing $10,000 with a robo-advisor charging an annual management fee of 0.5%, you’ll therefore pay $50 in fees per year. (Unless, of course, you open an account using one of the promotional offers featured on Hardbacon’s robo-advisor comparison tool.) Several-advisors lower the management fee percentage as assets increase, to reflect the fact that for a robo-advisor, investing $10,000 doesn’t cost much more than investing $100,000.
The ETF management expense ratios
These fees don’t have much to do with robo-advisors, but since most of them invest in ETFs, these are fees that investors must expect to pay. This is because the management fees advertised by robo-advisors generally do not include these fees, which are collected by the ETFs directly. Although they differ from portfolio to portfolio, the average management expense ratio for Canadian robo-advisors is typically 0.2% to 0.35%.
Most robo-advisors cover transaction fees, which are the fees they must pay every time they buy or sell securities (mostly ETFs). In other words, these fees are generally included in the robo-advisors’ management fees. However, some robo-advisors pass these fees onto their clients. Unlike the other two fees described above, (ci-dessous en version française) the transaction fees are not based on the asset under management, but on the number of transactions the robo-advisor carries out.
Differences amongst Canadian robo-advisors
The Canadian robo-advisors listed on Hardbacon’s comparison tool are very similar. And since they all rely on a passive investment strategy, comparing their past performances would be pointless. This is the reason why we have placed so much importance on fees in Hardbacon’s comparison tool. Despite everything, robo-advisors do differ from one another on several fronts. Here are, in my humble opinion, the main differences amongst Canadian robo-advisors…with the exception of fees.
The technological interface
As we saw above, there is not a lot of technology under the hoods of Canadian robo-advisors. Innovation is found more in client interaction, in particular in terms of opening an account and monitoring their investments. Not having tested the main robo-advisor services (but it’s coming), it would be difficult for me to give a nod to the top of the class here. On the other hand, it’s easy to identify the players that are the best-endowed in terms of technology, by highlighting which of them have mobile applications and which allow you to open an account entirely online. ModernAdvisor, WealthBar and Wealthsimple, for example, are the only three Canadian robo-advisors to have a dedicated mobile application and enable their new clients to open an account entirely online.
Integration into a brokerage (or bank) account
The rise of robo-advisors over the past two years hasn’t failed to attract the attention of discount brokers and banks. In order not to be left behind by these new entrants, several of them have launched robo-advisor services. This is notably the case of Portfolio IQ (Questrade), InvestCube (National Bank Direct Brokerage), BMO InvestorLine and Tangerine Investment Funds. These robo-advisor services have the advantage of integrating with the brokerage account and existing bank accounts of investors who are already clients of these institutions.
The degree of personalization
Personalization is one way that the smallest Canadian robo-advisors manage to stand out. This is notably the case with services such as Justwealth and WealthBar, which offer financial planning services, and Idema, which offers a personalized portfolio management service.
The types of assets offered
Most Canadian robo-advisors limit themselves to investing in exchange-traded funds (ETFs), due to their low fees. However, some robo-advisor services invest in mutual funds and even other financial products. This is particularly the case with Tangerine, which we have chosen to include in our robo-advisor comparison tool, despite that what this bank offers is not really a robo-advisor. Tangerine actually offers its own low-cost mutual funds, which have been designed to replicate different market indexes. Steadyhand, which is more like a robo-advisor, also offers its own low-cost mutual funds. Lastly, WealthBar, which offers its clients ETF portfolios like other Canadian players, also offers private investment products.
The presence of ethical portfolios
Investing in stock market indexes has several advantages, particularly in terms of costs. However, the downside to this approach is that you find yourself investing in almost ALL of the large North American companies. Also, for an investor concerned about the environmental and ethical records of the companies in which they invest, the index approach may appear less attractive. However, some robo-advisors have built socially responsible portfolios to accommodate this type of investor. Wealthsimple, ModernAdvisor and Idema offer such portfolios.
Are Canadian Robo-Advisors For You?
Now that you have a pretty good idea of everything there is to know about Canadian robo-advisors, it remains to determine if they’re a good investment option for you. If you have money invested in mutual funds or a full-service brokerage firm, and you don’t want to manage your money yourself, chances are you could do better with a robo-advisor.
Take a look at the fees you’re currently paying, and ask yourself if the advice and support provided by your advisor is worth that much. If the answer is yes, don’t transfer your money. The higher fees you’re paying now are used in part to compensate your advisor. If, on the other hand, you feel that you’re paying too much for the services you receive, Canadian robo-advisors are perfect for you.
If you invest your money yourself through a discount broker, be aware that robo-advisor fees are likely higher than what you’re currently paying. However, there’s one exception. If you have less than $10,000 to invest, as you’ll see in the promotional offers displayed in our comparison tool, investing through Wealthsimple will cost you nothing in management fees for two years.
For others, investing with a robo-advisor should cost slightly more than investing with a discount broker, provided you know what you’re doing. To find out which method is most suitable for you, take this short quiz. It’s easy to build an ETF portfolio in a brokerage account without much knowledge, by copying a model ETF portfolio found on the internet like those from Canadian Couch Potato. Then, you just have to take care of the rebalancing yourself, and you can get a product similar to what robots offer without paying a robo-advisor’s management fees. On the other hand, you have to pay attention to your investments and have an interest in this sort of thing. If not, robo-advisors are probably a good option for you. To help you choose a robo-advisor, don’t hesitate to use a comparison tool.
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