In Episode 13 of the Canadian Couch Potato podcast, we turn our attention to one of the most significant trends in ETF investing: the rise of robo-advisors. As Rob Carrick recently wrote in the Globe and Mail, “It’s time to stop treating robo-advisers as a novelty and start considering them as a smart option for people seeking help in building an investment portfolio.”
I haven’t written much about robo-advisors since they arrived in Canada back in 2014, because it’s been hard to get much deep insight into these firms. On one hand, the media love painting them as a massive disrupter in the financial services industry, but it’s not clear how popular they’ve been with Canadian investors. Most firms are silent about the number of clients they have attracted and the amount of assets they manage.
To inject a little objectivity, I spoke to someone with expertise but no vested interest in the robo-advisor space. Pauline Shum-Nolan is a professor of Finance at the Schulich School of Business whose research has focused on ETFs. She is also president and co-founder of PW Portfolio Analytics, a firm that provides risk analysis and other research services for DIY investors, advisors and institutions.
The future of robo-advice
Following the interview, I offer some editorial commentary about the robo-advisor space in Canada. While it’s true the technology should make it easier for DIY investor to manage complex portfolios, I don’t see this as a major selling point. On the contrary, I wish a robo-advisor would at least offer a plain old Couch Potato portfolio as one option: instead, virtually all of them add sector funds, smart beta ETFs, covered call ETFs, dividend-oriented funds, or even actively managed ETFs. Including these narrowly focused ETFs give the impression that their portfolios are “optimized,” even if there’s no evidence this actually improves performance after fees.
In my view, the other major challenge for robo-advisors will be finding a cost-effective way to add some level of human contact. Even if an investor doesn’t want or need to work with a full-service advisor, most people still need help that goes beyond choosing a portfolio of ETFs. It’s going to be difficult for robo-advisors to provide attentive service to small clients who are paying very low fees.
That’s why I think we may see more partnerships between robo-advisors and independent fee-only planners. The planners can offer advice about budgeting, savings strategies, risk management and so on, charging a fee directly to their clients. And since most are not licensed to provide investment advice, they can then farm out the investment decisions to a robo-advisor. Indeed, some robo-advisors (such as Wealthsimple and Nest Wealth) already offer “white-label” versions of their platforms so they can be used and branded by independent planners.
Should you borrow to invest?
In our regular Ask the Spud segment, I answer a question from a listener who wonders whether it’s a good idea to borrow to invest in index funds.
If you want an optimistic illustration of the potential of leverage, fiddle around with the calculator on the website of Raymond James, the wealth management firm: it’s hard to find any scenario where monthly savings looks preferable to borrowing to invest. Even if you assume a low marginal tax rate and muted investment returns, the leveraged option usually comes out ahead.
This touches on my first concern about leveraged investing: it’s rife with conflicts of interest. It’s usually promoted by financial institutions that lend money, or by advisors whose fees are based on a percentage of the assets they manage. Sometimes the firm recommending leverage is both the lender and the investment advisor, which I think should be illegal.
Illustrations of leveraged investing look rosy, but the risks are almost always understated. Certainly if you had borrowed five years ago and invested in a globally diversified portfolio of equity ETFs you would have done extremely well, as stocks delivered annualized returns over 14% and there were never more than two consecutive months with a negative return.
But try to imagine how you would have felt had you borrowed to invest in the early 2000s, just before the tech bubble burst; or in 2007, before the housing crash in the U.S. that ushered in the worst financial crisis of our lifetime; or in 2011, during the European debt debacle. Would you have been able to hang on with discipline as your portfolio mounted losses of 20%, 30% or more?
Investing in equities is risky and stressful enough when you’re doing it with your own money, but you’re ramping up that risk exponentially when you use leverage. Online calculators assume your investment returns will be reliable and consistent every year, but they never are.
That’s why my advice—especially if you’re a new investor—is to make regular monthly contributions and forget about building a portfolio with borrowed money.
I thought long and hard about your podcast content, and concluded firstly that I personally had absolutely no use for a robot advisor. My portfolio is simple enough for me to easily manually calculate the need (or lack of) for rebalancing when I review it annually. (I am retired, so I don’t usually make contributions to my non-registered portfolio. The situation is temporarily complicated by a need this year to partially cannibalize the portfolio to provide cash financing for an adult child’s home purchase, but still, the figuring out which components to sell, and the re-calculation for the rebalancing of the remaining assets is still pretty straightforward, apart from the tax implications, which a robot wouldn’t be of much help with, anyway.)
I then asked myself what person would really need the robot advisor. The answer, generally was “Any-one with a proposed portfolio that they didn’t feel confident enough to calculate out themselves.” This category would include those that had been led to believe they needed a complicated or actively managed portfolio (which they wouldn’t understand, anyway). To simplify my reasoning, I will just conclude that those people don’t belong in a discussion group consisting of committed Couch Potatoes. (Harsh, maybe, but I wanted to simplify the categorization).
That leaves those nominally converted to Couch Potato understanding, but, when it comes down to actually doing it, without the confidence to actually put that alleged knowledge into action. Having made the dramatic mental transition from Pre-Couch Potato to Couch Potato myself within the last few years, I think I have some insight.
Although the Robo-Advisor option for this group initially sounds attractive, the flaw is that Robot Advice has a seeming veneer of accuracy and perfection. If that automatic robotic advice indeed is based upon a simple arithmetical calculation of what to buy and sell to arrive at the predetermined asset allocation that the investor has independently arrived at as the very first step in setting up his portfolio, then fine, it is merely a convenient option for not doing the actual math, but the investor still is basically aware of the underlying principles of the calculations, because he/she is looking towards the final bottom line of a portfolio whose asset allocation matches the prescription embedded into that investors brain.
But if the investor was that clear on the final bottom line (the prescribed asset allocation that he/she had previously decided upon) it is unlikely that he/she would bother with the intermediary help of the Robot.
The default, then, is that those nominal Couch Potatoes still wanting to use Robot-Advisors will be the very ones that shouldn’t use them, because their seeming need for them is based upon lack of clarity on the underlying principles of non-clairvoyant, intelligently diversified, simple index based investing. If they really needed that false veneer of technical infallibility that the robo-advisor provides, it is likely that when any perceived trouble arises, they will panic, and not finding any comfort from the robot when they plead advice from it (in vain), will be at high risk of exiting from the Couch Potato program at the very worst possible time.
It is highly likely, I would think from my back-reasoning, that this potential robo-advised investor has not clearly defined his/her investment objectives, time scale and risk tolerance, nor settled on an asset allocation model that they can live with. At least, not to the degree of certainty and trueness to self that investing with equanimity requires. The Couch Potato principle is deceptively simple — it is simple in concept, and this simplicity helps to keep the investor clear as to what he believes, because in practice those beliefs will be tested in more little and big ways than would be apparent at first sight. But trusting your money upon those simple beliefs which you say you have espoused is a further and huge huge step which still must be done.There is no short cut to this important existential step, and I guess my niggling suspicion is that the Robo-Advisor may represent the short cut that shouldn’t be taken.
I’m sorry to drag on so, but I find putting this rather diffuse conceptual problem into words was tricky for me. Perhaps I should have left it at “Keep It Simple”. I hope my judgement doesn’t come out too harsh.
At 8:39 – “if you were to want to get rid of certain exposures, for example, let say I’m still concerned about the energy sector or I’m concerned about the IT sector…”
It seems like she is a fan of active management and complains about the fact that the Robo-advisors don’t customize every person’s portfolio. This is completely against the Couch Potato philosophy, no?
The only customization you need is to adjust the bond vs. stock percentage based on risk, but other than that, it is one size fits all despite the fact that many advisors and mutual fund managers like to charge you a lot of money based on the assumption that it isn’t true.
I see Robo’s as a cheaper alternative to your Tangerine funds portfolios, plus they give you advice on asset allocation, but if you were to use the ETFs or TD e-series funds, you’ll be better off. Maybe I misunderstood her criticisms and what she was trying to say.
@ Joey:
“plus they give you advice on asset allocation,…”
I don’t understand how Robo advisors could give you advice about asset allocation, except regurgitate the background teaching behind the reason why one needs to arrive at an asset allocation that you can live with which will not be subject to knee jerk tinkering with, timing attempts, and other thinly veiled attempts at predicting the near and intermediate future. In other words, I don’t see the Robo advisors performing an educational function any more efficiently than a book or website dedicated to Couch Potato-ism”, such as this one.
It can’t tell you what asset allocation would be best for you. Only you can do that for yourself. And to do that, you have to understand at a very fundamental level the basic principles of Couch Potato investing. And if you have got that far, you can do all the rest yourself, no?
@Oldie: I meant what risk to have in your portfolio – what % of stocks and bonds. You can figure out your own allocation yourself and I think true DIY couch potato investors are better off by themselves. But for people who know nothing about investing and don’t want to learn, the Robo’s can put you in a well diversified portfolio with the appropriate level of risk with a reasonable MER. As Dan said, it would be better if they stuck with only low cost, cap-weighted funds and they do try to mix lots of asset classes (I think to appear more sophisticated), but relative to the mutual fund industry, it’s much lower fees.
@ Joey:
“But for people who know nothing about investing and don’t want to learn”
My worry would be that if they don’t want to learn, then they only have a thinly understood idea of what it means to not being able to predict the future. They may well start off with a reasonable sensible Couch Potato portfolio (robo prescribed or lifted off this website), but, not truly understanding the basic principles (=”don’t want to learn”) they mis-understand that it will protect them from “significant” fluctuations in value. I guess you can’t protect people from everything if they willfully profess to put themselves at risk before undertaking to understand what the risks are. But the “Robo” idea sounds (to a non-sophisticate, at least) like it has the answer to everything, including magically switching your portfolio out of danger at the right time. I know that sounds goofy to us who know that this task would be impossible to perform accurately — but “don’t want to learn” includes not having the intellectual discipline to understand the ramifications of Couch Potato wisdom “you can’t predict the future, so you shouldn’t try”. This sounds trivial, but I think it isn’t, and thus Robo-advisors shouldn’t be seen as the reasonable alternative to “don’t want to learn.”
I think a real human advisor can at least gauge your understanding of what you say you understand (of Couch Potato investing, that is) and help gauge your vulnerability to shock when the crash comes. And help hold your hand and not panic-sell at that time.
I think I’ve beaten this one to death, so I should just shut up.
MIND and AIEQ. And other AI ETFs.
What’s your opinion of then? I know they’re new so there’s no data sample. But would they be able to outperform human active management? What about passive indexing?
“On the contrary, I wish a robo-advisor would at least offer a plain old Couch Potato portfolio as one option: instead, virtually all of them add sector funds, smart beta ETFs, covered call ETFs, dividend-oriented funds, or even actively managed ETFs.”
Hi Dan,
Just looking at Wealthsimple’s Growth portfolio here:
https://help.wealthsimple.com/hc/en-ca/articles/115015750707-When-should-I-be-in-the-Growth-portfolio-
Maybe I’m mistaken, but it seems that it is comprised of entirely index funds. The only non-CCP fund seems to be VUS which is hedged to the Canadian dollar. I can’t see this being enough of a deterrent to instead choose say, Tangerine, which has double the fees (and even more once a Wealthsimple Black account is achieved). Thoughts?
My main gripe with Wealthsimple is that they recommend a Balanced portfolio for young investors, which consists of 50% bonds…way too much in my opinion.
@Zach: The portfolio you linked looks fine: more complicated than necessary but these are quibbles. Have a look at Wealthsimple’s balanced portfolio for an example that includes actively managed ETFs. You should be able to speak to someone at Wealthsimple and get whatever asset allocation you feel is appropriate.
As a couch potato in the accumulation phase I have little use for a robo-advisor. Investable funds are put into the fund that is underweight. I very rarely sell to rebalance. If they were to provide simple 3 fund or 5 fund indexes I can see them in my future in two circumstances:
Keeping the balance during spending phase:
Keeping a retirement index portfolio in balance during the spending phase might be tricky. I’d want to make sure that I’m not spending all of one asset class and I don’t want to fall into trying to market timing my sells. A robo-advisor could possibly be told to keep 6 months of future withdrawals in a HISA and sell units or redirect distributions appropriately to keep the asset mix I’ve prescribed.
Maintaining my plan when I no longer can:
There may be a point in my dotage where I can no longer maintain my investments. My spouse might outlive me and have no interest in investing. Instead of falling back on a human adviser eager to tear up our tried and true plan, I should be able to count on a robot to emulate me.
@Sam:
“Keeping a retirement index portfolio in balance during the spending phase might be tricky.”
How tricky? Depending on how many months in advance you want to do the withdrawals (to minimize the frequency of $9.95 per trade costs, balancing against the fact that for instance, some people don’t mind frequently paying $1.50 per ATM cash withdrawal) would seem to be the only judgement call you need to do.
Otherwise, with a 3 ETF portfolio it would seem trivial — do the calculations for what the dollar mix the asset balance would predict assuming you have extracted $X dollars (the amount of cash you want to live on for that number of months) of value from the portfolio. Then divide the dollars worth per asset category by the ETF share cost to get the number of shares you want to end up with for best approximation of ideal balance today (as you say, don’t get caught up with thinking about smart market timing of sells — but I think about “guessing what’s going up” myself all the time, so I admit it’s hard to completely tune out those thoughts), and then do the required number of sells to end up with that mix, maybe omitting the sells of asset classes that are within a few hundred $ of the ideal prescribed value for that asset (i.e don’t spend $9.95 to liquidate $300 of asset if otherwise the percentage discrepancy is still trivial).
Your point about what to do as you approach your dotage had me thinking about my own age lol. But way before that point, maybe I had better gradually adjust my Equity : Bonds ratio to the absolute lowest that I would want it to be (i.e same as what I would expect it to be when I die and it needs to be liquidated to determine the worth of my estate, maybe 20:80). I don’t know how much a robot company would charge compared to a human advisor entrusted with keeping your Couch Potato asset mix sacred. But if you had it in writing, the human advisor could not violate your wishes. Besides, in your dotage you would start to require having a human administrator doing the routine financial arrangements, paying the bills, arranging for your nursing home etc. These arrangements may involve your family, but there would be still be administrative costs involved anyway. Maybe that’s the key — have a plan in writing as part of a living will, known to your relatives, but backed up by a formal document.
Hi Dan,
I have a quick question for you. Would I be able to make investments being a non-citizen. I am currently on my work permit and would like to make investments. Also I read somewhere about withholdings. Could you please let me know or direct me in the right direction.
@Jay: You don’t need to be a citizen to invest in Canada, but you may need to be a resident to open an account. Best to contact a brokerage (perhaps one of those run by the big banks) for guidance.
Hi Dan,
PW Portfolio Analytics, a firm that provides risk analysis and other research services for DIY as we all know you did a pod cast with Pauline Shum-Nolan.
I recently got a email to test drive there new software program lots of numbers to look at and absorb.
How do you feel about this software, and its abilities to analyze a persons risk in their portfolios depending on their chosen asset allocation, I will say i like the reits that are included as a lot of asset mixers don’t have a setting for REIT allocation. Thanks in advance.
@mark: I’m afraid I have no experience with this software and can’t offer any feedback.
“I haven’t written much about robo-advisors since they arrived in Canada back in 2014, because it’s been hard to get much deep insight into these firms. On one hand, the media love painting them as a massive disrupter in the financial services industry, but it’s not clear how popular they’ve been with Canadian investors.”
Hi Dan,
I was curious what you meant by getting ‘deep insight’ into the robo advisor firms. They seem to operate on an algorithm and showcase different portfolios like other investment fund sites.
And re: not being clear on how popular they’ve been with Canadian investors — I was under the understanding that WealthSimple, for example, now has over $1 billion in assets managed so they seem to be quite popular (those clever ads certainly helped them).
I’m currently debating switching from my Tangerine index funds and going the robo advisor route but haven’t pulled the trigger yet. But I am definitely curious with WealthSimple for example because they have an option for a “socially responsible” investments which I haven’t seen anywhere else so far.
Thanks for all of the work you’ve put in to CCP, discovering it a few years ago is what made me become more empowered with knowledge and drove me to start investing seriously and with agency. Cheers!
@Freddy: Sorry if these comments were a little vague. To me the unanswered questions include the quality of service offered by robo-advisors. How good are they at answering questions and resolving problems experienced by clients? Several of them say they offer financial planning, but it’s hard to know the scope or quality of these services.
As for Wealthsimple managing $1 billion in assets, this isn’t a very large number in the financial industry, and some $400M of that was the result of their purchase of ShareOwner, and therefore does not reflect the popularity of their own service. This isn’t a criticism of Wealthsimple or anyone else, it’s just an observation that, as popular as robo-advisors have been on blogs, forums and the media, I don’t think they’re making a big dent in the industry yet.
If you’re interested in SRI, ModernAdvisor also offers this option:
http://blog.modernadvisor.ca/socially-responsible-etfs/