The power to right investment wrongs

"Robo advice" may sound like a buzz phrase, but the concept is very simple: a computer is told to find the mix of investments that will deliver an adequate return with minimum risk. The reason a computer is good at the job is because it involves many thousands of computations. That's the type of work humans were happy to hand over to computer programs decades ago. The process isn't totally clinical, however. A user needs to start with a realistic investment target.

The reason a computer is good at the job is because it involves many thousands of computations. That's the type of work humans were happy to hand over to computer programs decades ago.

The process isn't totally clinical, however. A user needs to start with a realistic investment target. Also, the investment options should suit the user. They may not all be included in the portfolio the robo advice model generates, but the user should be comfortable that they are appropriate and offer good value.

This is where the banks may find themselves under the scrutiny of the financial regulator. Most existing robo advice services approach the portfolio construction task from scratch, and assume the user owns no other assets.

Their recommendation may be a portfolio of exchange-traded funds, for example, which will very likely mean considerable overlap with the user's holdings within superannuation or personal portfolio.

A proper robo advice tool would take into account a client's current assets, which is, of course, no trouble for a computer programmed for the task.

It means the user has to spend a bit of time feeding in more information at the start, but it's a powerful tool that can demonstrate where a portfolio may be underweight or overweight in any given asset class, taking into account the client's risk tolerance.

If an investor is in retirement, for example, they are probably not in a position to be heavily invested in the stock market alone, and should be encouraged to hold more cash and fixed interest-type assets. That is helpful "advice", and free of the subjective bias of a human adviser.

InvestSMART would argue that a true robo adviser should include a user's current investments (as a real life planner would) otherwise the software is nothing more than a glorified product wizard.

A robo advice model that ignores existing investments will always produce a wonky portfolio. Robo advice is a very generic term, and lots of companies will join the bandwagon.

It is very easy to ask five questions with the aim of directing users to a few preferred products. But that sounds more like a low-cost automated distribution service than objective automated advice.

Instead, robo advice can be a simple tool that educates investors about the benefits of diversification and shows them better ways to construct a portfolio, where expected returns are in line with a user's investment time line and risk appetite.

Ron Hodge is managing director of InvestSMART.

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