Robo Advisors: What They Are and why You (and I) Might Need One

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This article was sponsored by ModernAdvisor.

Even smart people can make stupid money mistakes.

Take me for instance.

Not to blow your socks off, but...

I’m a reasonably smart guy.

I worked hard and did very well in school. I have a degree in computer science. I come from a family that has logic-wired brains.

And to top it off my dad is an investment advisor.

You’d think if anyone could make half-decent investing decisions it would be me, right?

Well, I hate to burst my own bubble. But...you’d be wrong.

My Personal Investing Horror Show

My dad helped me start investing young even though I really wasn’t that interested. He opened an investment account for me and gave me a few hundred dollars to invest in anything I wanted while I was in my late teens.

This was the 90s and at the time Nortel was all the rage and completely dominating the Canadian stock markets. At the time I was fascinated by technology … and snowmobiles.

Awesome technology company with amazing past performance - what better reason to invest? I used half my money to buy up Nortel stock of course.

Let’s not forget the snowmobiles though - I used the other half to purchase Bombardier, the maker of Skidoos … and airplanes … and other fast-moving things.

You know what happens next - I became instantly and unmeasurably rich, of course!

No wait … those are my dreams for the future … what actually happened is Nortel went to 0 after a series of scandals and missteps causing me to lose my entire investment.

Bombardier? Things started well. After buying in at around $6 per share its value skyrocketed to $26 per share … but then the stock price plummeted to about $3 per share in the early 2000s and hasn’t recovered since. I eventually sold losing about half my money.

Net gain: -75%.

After that amazing start in the investing world, I did the smart thing and let my dad invest any money I had for the next several years. I don’t remember the exact results, but I definitely made good returns with him.

Let’s Try DIY Investing

The year is 2008. I’m older and wiser … and now I’m following personal finance blogs that cover investing and am reading endless threads on personal finance forums - low cost DIY investing here I come!

So I called up my dad and told him I was firing him to tackle this whole investing thing myself - I think he was a little bit heartbroken (pretty sure he’s over it now though).

I opened up a shiny new Questrade online discount broker account, cashed out all my personal and work investments, and transferred everything over.

Then, I proceeded to make every stupid investing mistake in the book, some for a second time:

  • I tried to time the market during one of the most volatile times in stock market history (2008) for a few weeks.
  • I played with leveraged exchange traded funds (ETFs) at the same time. That means gains and losses are doubled in the short term. Long term, I found out if markets go up and down a lot over a period of years, you eventually lose all your money. Good thing I came to my senses quickly and stopped.
  • I avoided buying individual stocks at first and diversified across Canada (good), but neglected to diversify worldwide (bad).
  • After watching several stocks for fun over time I decided to buy Yellow Pages due to its long track record of paying big dividends to investors and its stable stock price.

Did I pay big for these mistakes? Not so bad this time around…

By cashing out and timing the market, I actually missed one of the biggest single day drops ever plus a few more big drops. That combined with only minor losses from the leveraged ETFs had me come out slightly ahead of the index.

During my period of lack of global diversification, Canada did well enough and I avoided a lot of the problems in Europe. In the later years Canada started to underperform though and I missed out on some global gains.

Yellow Pages? You guessed it - it almost went to 0 and I lost several thousand dollars. I’ve learned my lesson now. Promise.

My overall returns? In my main RRSP account I haven’t achieved the 6-8% expected average annual returns, but I’m much better off than the typical savings account at about 5%. My TFSA is looking better at 14.79%, but I didn’t start it until 2012.

Today I have a globally diversified low cost investment portfolio of ETFs that are delivering market returns over a long time horizon. It took me a while to get there, but that’s exactly what I should have done from day one.

Robo Advisors Can Help You Lower Fees and Avoid Mistakes

I recently sat down with Navid, CEO of ModernAdvisor, one of Canada’s lowest cost Robo Advisors to ask him some questions to help demystify this new way of investing. I’ve summarized his answers below.

1) “Robo Advisor” sounds scary - what does it actually mean?

According to Navid, the name is a rather unfortunate one that stuck. He prefers the term “online investment advisor” because that more accurately describes the service.

A Robo Advisor is a service that helps people invest their money using low cost globally diversified funds in a way that matches their long term goals and risk profile.

Technology is used to make the process easy for everyone, keep costs low, and take out much of the human error that can creep in when making investing decisions.

2) How can a Robo Advisor save me money?

There are two main ways:

First, low cost exchange traded funds (ETFs) that are diversified across the entire stock market and other lower risk investments are used in place of expensive “actively managed” mutual funds. In my trial ModernAdvisor account these funds have an average cost or Management Expense Ratio (MER) of 0.21% per year. Mutual funds are 10x more expensive with an average of 2.35% in Canada - the highest in the world.

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Paying so much more, you’d think you’d get better investment performance out of mutual funds, but that is typically not the case. Many mutual funds are actually “closet index funds” - which means they really just track the stock market the same as cheap ETFs. “Actively managed” is often a big illusion.

Many studies have been done on the difficulty of outperforming the stock markets - especially after paying high MERs. Few fund managers have accomplished this consistently. That means picking a fund manager becomes nearly as difficult as picking individual stocks. The golden rule still applies: past performance doesn’t predict future performance.

Second, the fees charged for the actual Robo Advisor service are very low ranging from 0.35% to 0.5% annually depending on portfolio size with no extra charge for trading fees.

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That means on a $200,000 portfolio you’d be paying a total cost of $1,220 yearly vs. $4,700 with a typical mutual fund - a difference of $3,480. That’s 0.61% in total fees with ModernAdvisor and 2.35% for the mutual fund.

Over the long term, that difference really adds up. For example, let’s consider the same $200,000 investment over a period of 30 years assuming a 7% annual return for both. At ModernAdvisor you’d end up with $1,282,490.81. Mutual fund? $782,000.40. That’s an extra $500,490.81 for your retirement - 64% more.

3) Why choose a Robo Advisor over DIY investing?

Navid says that the biggest obstacle investors have is ourselves. I think I proved that point nicely with my story above. One of the following scenarios usually hits even the most disciplined person:

  • You get a hot tip about an individual stock from a friend, the media, or a colleague and you just can’t resist!
  • You get nervous about volatility in the stock market and start trying to time the market. You inevitably buy or sell at the wrong time and either experience big losses or miss big gains.
  • You unconsciously let your asset allocation drift from your target over the years.
  • You start a family or advance your career and wind up too busy forgetting to invest more money and keep up with your portfolio.

Navid likens DIY investing to “going to an all you can eat buffet every day for every meal”. Sure you could remain healthy doing that if you are very careful - but seriously - what are the odds?

4) Do computers really make all the trades and investing decisions?

Sophisticated computer algorithms have been created to both monitor individual investor accounts for proper asset allocation, invest new money, and determine what trades need to be executed on the markets. These algorithms are created and verified by investment professionals to make sure only sound investing decisions are made.

Before any trades are executed, they are human-verified to make sure nothing unusual is taking place - like a flash drop in the markets for instance - that could cause a poor trade with an unfair value to take place. Once verified, the trades are executed and individual investor accounts are updated accordingly.

5) Can I speak to real people and get personal advice?

Yes, there is a team of real people at ModernAdvisor ready to speak to you and answer your questions about account types, risk, asset allocation, investing goals, and to provide general assistance. They are available on demand by phone or online chat.

In fact you can even speak to the CEO Navid himself. While testing out their online dashboard I decided to start a chat to see how responsive they were. I had a response from Krysten in less than a minute and to my surprise Navid jumped into the conversation a minute later.

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What most Robo Advisors don’t offer is a full range of financial planning, which includes things like a written financial plan. The sad part is that many “financial advisors” that sell you overpriced mutual funds and reap the long term profits barely call you once a year, let alone give you a written financial plan.

The good news is that there are fee-only financial planners out there to help you with that for a one-time fee of around $1,000, which is quite a bargain when you think about it.

6) There are at least 10 Canadian Robo Advisors out there, why choose ModernAdvisor?

Researching this article, I discovered that there are at least 10 Canadian Robo Advisors out there right now.

Navid says that less than half of those actually offer their service Canada-wide, which cuts the field down for many of us right away.

Then he goes on to point out these other differentiators about ModernAdvisor. They...

  • Put extra effort into their online interface to make it user friendly and, as a software developer, I have to agree that it is simple and easy to use.
  • Use a selection of regular diversified ETFs as opposed to more exotic ETFs that can have extra hidden fees and might not offer market returns.
  • Have one of the lowest overall fee structures of all the Canadian Robo Advisors.
  • Are committed to offering their clients great responsive service - even responding to clients after hours and on weekends.

7) Why should I trust you with my money - what if you get hacked or go out of business?

Security is a big concern when it comes to our investments, so I wanted to make sure Navid had a good answer to this question.

He responded by saying they have multiple safeguards in place and use bank-level encryption to protect their site and client accounts. They go through regular security audits and penetration testing by a leading security firm.

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In fact, your money isn’t held directly with ModernAdvisor, it is held by a 3rd party custodian called Credential Securities that houses over 25 Billion in assets. Their clients include other large Canadian financial institutions and credit unions.

Additionally your money is protected by the Canadian Investor Protection Fund (CIPF), which will reimburse you for any lost money due to one of its members going out of business. This covers you for up to 1 Million dollars in assets.

8) How do I get started and how do I contribute new money?

You can start by heading over to the ModernAdvisor home page and click on the Get Started with ModernAdvisor button.

Then, you will go through an easy to follow sign up process that involves setting your investment goals, your expected initial and ongoing contributions, providing some details about your current financial situation, and assessing your risk appetite.

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Then, once your profile is set, you’ve chosen your investment plan, and you’ve created your user ID and password, you will have access to the dashboard.

To complete the account opening, you’ll need to provide your SIN number for identification and tax purposes then snap and upload a couple of pictures of your government issued photo ID and bank statement. After a couple of business days for verification, you’ll be ready to start investing.

Whenever you want to contribute new money, you simply add your ModernAdvisor account as a payee in online banking and make a payment. If you want to do this regularly, simply set up a recurring payment. The money automatically gets invested once it is received according to the investment plan you chose.

9) Can I try it out before I commit my money?

ModernAdvisor is one of the few Robo Advisors allows you to create a trial account without the need to provide money, SIN number, or banking information. Better, they will invest $1,000 of their own money on your behalf for 30 days.

If the $1,000 earns money in that 30 days, you get to keep all the gains if you decide to finish opening your account and start investing your money. If the money is lost, you aren’t responsible for the losses, they are.

I’ve had my trial account for nearly a month now and as you can see I’ve lost about $25 so far. That’s completely expected because of the big Brexit vote confirming that the United Kingdom is going to exit the European Union. Whenever big news like that happens, there is always turmoil in the financial markets and some investors get scared and start selling lowering all markets.

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That’s the nature of investing - ups and downs (sometimes big ones) - but the markets as a whole have a lifetime track record of always going up more than they go down.

My Take on Robo Advisors

I think Robo Advisors are the perfect bridge between low cost DIY investing and high fee mutual funds for everyday people who don’t have the time or inclination to manage their own portfolios.

If ModernAdvisor existed when I started investing, I would almost certainly be further ahead than I am now. I would have avoided costly emotional investing mistakes and probably contributed more money because it is so easy to set up recurring automatically-invested payments.

For now, I’m planning to stick with my ultra low cost globally diversified ETF portfolio because I’ve finally got it nailed down and working well after years of growing pains. In the future, if I become frustrated with managing and rebalancing my own portfolio, going with a good Robo Advisor is the most likely path for me.

Free Trial and $50 Bonus for HTS Readers

Navid has graciously agreed to provide HTS readers with a $50 bonus for opening a new account in addition to the free 30-day trial and gains on the $1,000 they invest for you.

Use this code: HTS2016

Get your trial account & bonus here

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Comments

Scott
Scott's picture

Very cool, Stephen! I've been taking some vacation, so I've been catching up on some of your articles. A lot of great content. I'm VERY new to the DIY scene, so I have much reading and learning to be done. Thanks for your efforts!

July 29, 2016 @ 2:17 pm
Stephen Weyman
Stephen Weyman's picture

Yes, it can seem like a mountain at first - but keep at it. You'll find yourself in the know much faster than you think and it will all start to seem easy.

July 30, 2016 @ 3:19 pm
Benjamin
Benjamin's picture

Thanks Stephen I really enjoy reading your saving tips.

About this article, I always wanted to try to invest by my own rather than mutual funds.
I would like to invest but withing my rrsp, i wonder the steps to follow to open an investment account within the rrsp

February 08, 2017 @ 12:44 am
Stephen Weyman
Stephen Weyman's picture

Robo advisors offer RRSP as an account type. You should be able to just get them to transfer over your existing RRSP. The only hiccup would be if it is tired to your current employer. You probably wouldn't want to close out your existing RRSP account in that case.

February 12, 2017 @ 9:00 pm

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