Can robo advisors fit into your financial plan?

Every so often, the financial services industry takes a run at automated portfolio solutions – black boxes where the investor puts money in and takes returns out. Today’s iteration of this is the so-called “robo-advisor” or “robo-portfolio.” It’s a catchy buzzword, but the question is whether these will perform any better than past efforts at automation, and whether such a product is, in fact, right for you.

I look at this issue strictly from the client’s perspective: The client’s investment portfolio must be a result of a client’s detailed financial plan. The plan should always come first. The plan should always determine the asset mix, tax profile, and degree of risk of the resulting portfolio.

Unfortunately, in far too many situations, the portfolio is created first and then a general financial plan is created second. Even worse, in some cases the financial plan is used as a sales tool to either encourage greater investments or the purchase of additional insurance, which may not be the real priority for the client.

Fee for service

In my practice we provide fee-for-service financial advice. It always amazes me the number of calls we get each month from people who want to work with a fee-only advisor. The common thread among these calls is that they are tired sitting across the desk from someone who will provide for them a financial plan for “free,” but typically only if the client then purchases a product from the advisor.

Clients want competent, unbiased advice, and they are prepared to pay a fee for receiving this advice. Yet they are finding it difficult to find advisors in their community who will provide such a service.

So here’s the really big question: Is the key to a client’s long term financial success the product or the plan?

In my book, Master Your Retirement, I focus on what I call the “5 Great Killers of Wealth.” If you wish to achieve your financial and lifestyle goals, you must first address these head on. Therefore, the key to long-term financial success lies squarely in the plan, which illustrates how best to allocate income and capital in a tax-effective manner, so as to consistently build, growth, protect and transition wealth over time.

From plan to product

Now let’s build a bridge between the plan and the product.

Part 1 of the ideal outcome between the plan and the product is technology. All firms will need to use technology efficiently and effectively so as to manage costs and reduce risks. All firms will need to be, in some manner, a robo-firm. But this may be “just another” product or process innovation that does not get to the heart of what is really the most important: finding a well-qualified, experienced, professional financial planner.

This brings us to Part 2 of the ideal outcome. Canadians need to get used to the fact that we may need to pay financial planning fees in the same way we pay fees to doctors, accountants, and lawyers. You see, if you pay a fee directly to the advisor, then the costs of most investment products will most likely decline as a result.

What are you really paying for?

Part 3 of the ideal outcome is reducing product costs. Why will product costs decline if you pay financial planning fees directly to a qualified financial planner? Well, did you know that you are already paying these fees, yet possibly receiving little to no value?

Currently, most financial planning fees are already bundled together with the portfolio management fees. For example, with most mutual funds, the mutual fund advisor receives a net fee of approximately 0.75% of the value of your portfolio. This is the approximate fee amount that clients will begin to see in their statements beginning December 31, 2016. For every $100,000 invested, this works out to be approximately $750. But are you getting value from this money spent?

If you had a $500,000 portfolio, are you receiving consistently each year $3,750 in financial planning value? How much better off would you be if you received $3,750 in professional advice and services? And for the small investor with $10,000, if you are starting out, how much great advice can you expect to receive if the advisor is earning only $75 a year? Would you be much better off if you received advice on how best to build a bridge between all of your financial goals and you paid a fee of $750 to $1,000 every few years? In my view and experience, the answer is a resounding yes.

In my view the best solution is always one that begins with a focused, detailed, integrated financial plan that is paid for by the client on a fee-for-service basis. Then, when the plan is complete, the plan will dictate the portfolio design.

If part of the portfolio can benefit from a low-cost, robo-style product, then that should form part of the portfolio solution. However, to achieve the client’s specific risk and return goals, tax-efficiency needs, and income goals while also keeping portfolio costs low, it is clear that a customized multi-product/multi-style approach to portfolio design is necessary. In other words, a pre-packaged Robo-product approach is actually not much different than the previous product innovations of the past, which is why I get that déjà vufeeling all over again. We’ve seen this movie before.

While the low-cost robo approach may form part of a solution, it is unlikely that it will be the full solution, which can be determined only if a comprehensive financial plan is first prepared.

Ready to robo?

I don’t believe than anything important in our life should ever be put on auto-pilot. I can’t imagine what my life would be like if I had a robo-physician, robo-fitness coach, robo-dentist, or robo-tax advisor. The tools and technology they use may be very sophisticated and may help to keep their costs down, in the same way that a robo-advisor product can help to keep portfolio management costs down. But in the end, it will be someone’s expert advice that will provide the greatest benefit and long term value.

We need to change the focus of the debate. The debate is not about whether it’s better to robo or not robo. Instead, the real debate should be how to get the very best, unbiased, professional financial advice to Canadians, in an efficient, cost-effective manner.

Get ready Canadians! If you really want this result, you should embrace paying fees to your financial planning advisor, so that you can then also receive the benefit of greater, long-term compounded growth from a lower-cost portfolio.

Courtesy Fundata Canada Inc. © 2016. Doug Nelson, B.Comm., CFP, CLU, CIM, is President of Winnipeg-based Nelson Financial Consultants. This article is not intended as personalized advice.