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.