The investment sector is constantly evolving, and the robo advisor trend is arguably one of the biggest disruptions to the industry since the advent of the internet. Robo advisors are digital platforms that provide automated, algorithm-driven financial planning services to clients (with guidance and FAQ services provided by humans). This new alternative to conventional financial planners is intimidating to some, as the norm has typically been to build an ongoing relationship with a personal advisor at a bank or investment firm where they open a TFSA or RRSP, in hopes that they will place your best financial interests ahead of the underlying profit motives of their employer.
This assumption has largely remained unquestioned over the years, however recent developments in robo advising have led people to consider whether these new platforms have the client’s best interests at heart, or whether it is best to stick with a traditional advisor.
Fiduciary duty is a complex concept. Essentially it boils down to a requirement that all investment advisors will put their client’s best interests first and foremost when advising them on investment decisions. The Investment Funds Institute of Canada (IFIC) regulates this aspect of the advising industry, stating that “All advisors are required to deal fairly, honestly, and in good faith with clients, and observe high standards of ethic and conduct in the transaction of business with clients.” Banks and investment firms will jump through hoops to present their financial advisors as fiduciaries who meet (if not exceed) all requirements put forth by regulators; however, the truth is that many Canadians remain disillusioned by their advisors, quoting ‘hidden fees, non-transparent commission structures, and advice that may not be putting the best interests of the clients first.
A nationwide survey by Genesis Public Opinion Research for The Globe and Mail found that less than half of the respondents gave their advisers top marks on such critical measures as recommending investments that suit their financial goals and selling products clients fully understand. Experts say that too many Canadians don’t understand what’s behind the investment advice they’re getting, and more importantly, how much they’re paying for it. The truth is that many people that call themselves “financial advisers” do not in fact have any fiduciary responsibility to their clients, and consequently can legally put their own needs ahead of their clients.
In many cases, the financial advice investors receive is coloured by the advisor’s needs, including a desire to keep their job and associated commissions. Buying, selling, and just holding on to mutual funds (many with high fees) for example, is a common way for advisers to earn a living. So why is it that despite years of questioning whether traditional financial advisors uphold the highest standards of fiduciary duty, many are now criticizing robo advisors for the exact same thing?
Fiduciary Duty and Canada’s Robo Advisors
In the United States, it is legal for similar robo advising services to manage client funds with little or no involvement of an advising representative. This lack of direct regulation has cast a shroud of doubt around the legitimacy of the industry. The two major financial regulatory bodies in the United States, FINRA and the SEC, issued a joint warning about robo advisors in May of 2015, saying that these services often make assumptions or recommendations based upon faulty information, wrong assumptions or circumstances that have no bearing on the client. It also said that the questionnaires that these platforms use can be incomplete, ambiguous and misleading and may be designed to lead the user to solutions that use proprietary investments, such as a specific fund or other investment company.
In Canada, however, this simply isn’t the case. Robo advisors are actually regulated to a much greater extent than most traditional advisors. The fact is, robo advisors have no choice when it comes to upholding their fiduciary duty, whereas traditional financial advisors have more flexibility to maximize their own profits. Regulations in Canada mandate that robo advisors must register as portfolio managers, which means that they have a legal obligation to act as fiduciaries on behalf of their clients.
This is in direct contrast to the conventional industry, where nearly anybody can label themselves as a ‘financial advisor,’ and provide advice while not being legally bound to a set of regulations which enforce their status as a fiduciary to their clients. In short, when you are dealing with an in-person financial advisor you do not actually know whether they have your best interests at heart, whereas with a robo advisor you are legally guaranteed that they in fact, do.
Beyond the regulatory safety nets, robo advisors are actually a very smart way for passive investors to manage their portfolios. Robo advisors have come a long way since their advent at the beginning of the 21st century. Several robos now operate in Canada (including our top-ranked pick: Wealthsimple). These services simplify investment by offering a limited range of portfolios, usually based on exchange-traded funds (ETFs). Clients of robo advisors permit the algorithms to rebalance their investment portfolios when the balances vary from the targets the clients allocated. These targets are typically determined by a simple questionnaire that prospective clients can fill out online, and in most cases, the service is augmented by a chat line, phone, or e-mail advice.
Finally, because robo advisors are the new entrants into a heavily-dominated sector, it is in the best interest of companies operating them to provide their clients with top-quality advising. The underlying profit motive which can influence the advice given by traditional financial advisors is completely removed by the flat-fee structure typically used by these new systems, and the only goal is to build the reputability of the new industry by providing clients with quality, unbiased advice. Continuing to act in their client’s best interests by disclosing potential conflicts and justifying their investment choices in a clear and concise manner could very well be the key to the future success of the robo advisor model, and this is well-known in the industry.
Investors needn’t worry about letting an electronic system (or “robot advisor”) manage their portfolios, in fact, they should be much more concerned about receiving poor or biased advice from a traditional financial advisor!
January 2018 Robo Advisor Update
If you still aren’t convinced that robo advisors are safe from fraud and shady practices (or as safe as any other type of wealth management practice in Canada – obviously overall returns can never be called “safe”) the fact that two major Canadian banks have now entered the fray should ease your mind. We get it – your Canadian. That means that you are inherently cautious with your money and you simply enjoy the safety blanket that is our 5-6 Canadian bank brands. If that’s the case I recommend that you check out our BMO Smartfolio review and our RBC InvestEase review. These two robo-esque platforms still offer solid mid-point options between opening up a discount brokerage account and doing DIY investing, and going the traditional mutual fund plus advisor route. You’ll pay a little more for the security of the major brand name, but hey, if that helps you sleep at night it’s probably well worth it.