24 Jul 2016

Robo-advisory Will Be the next ATM

Investing is very complex. There are concepts to understand, like asset allocation, taking risk to get a better return, and diversification. There are dozens of flavours of mutual funds, and a ton of jargon thrown at you. Then there are fees, loads and taxes.

Earlier, you had to learn all this the hard way — by reading books, magazine and newspaper articles and blogs, watching lecture videos, discussing with colleagues, and so on. You’d invariably make mistakes, make the wrong investments, and lose some returns that way. If you’re smart enough, you’ll look back, understand the mistakes you made, and fix them.

One solution is a financial advisor. Unfortunately, they charge a high price, like 20K or more per year, which turns away most people. Partly because they don’t understand the value of one. Why will people pay a high price for an unknown service with an unknown benefit? Only after I bit the bullet and signed up with a top-quality advisor did I realise that he saves much more money than he charges. Humans raise other concerns than pricing: are they competent? Do they have a conflict of interest?

There’s a better way — robo-advisory. You sign up with a robo-advisory web site, and tell it your financial goals, your assets, and your liabilities. It then tells you how to invest to meet each of your goals, makes sure you have no blind spots in your financial planning, and points out mistakes that you made, with instructions on how to fix them.

An automated service can be free, like Gmail or Simplenote is. Or much cheaper, like ₹999 a year rather than ₹20,000. A computer is less likely to have a conflict of interest. Computers don’t make mistakes when they’re tired. An algorithm, once you review it, always gives the right answer. A human takes days or weeks to get back to you, compared to a computer, which responds instantly and is available 24x7. Humans also don’t scale — I work with a top-quality advisor, but there’s no way he can serve a thousand clients.

Things You Shouldn’t Do

Let’s look at some aspects of robo-advisory in detail. One important aspect is correcting mistakes you made in the past, and teaching you what you need to know so that you don’t repeat the mistake. And financial planning is so complex that all of us have made at least one mistake with our investments!

There are a whole set of mistakes that a computer can help you identify, by asking you questions of the form, “Did you do X?” If you say yes, the site will tell you that that was a bad decision, explain why, tell you what to do instead the next time, and tell you fix the mistake already made, ideally with a single click.

For example, a robo-advisor can ask you, “Do you have any regular funds in your portfolio?” If you answer yes, it will tell you that you’re paying more fees compared to a direct fund, estimate how much more (which could be more than the robo-advisory site’s fee), suggest switching to a direct fund, and give you a button to execute the transaction then and there.

This is just one example of things you shouldn’t do.  Here are others:

- Do you invest directly in shares? Unless you have insight or knowledge about a company or an industry that nobody else in the world has, and wish to make investing a second job, you’re better off with a mutual fund. Most people who think they have a unique insight don’t.

- Do you have an index fund in your portfolio? Switch to actively managed funds, which perform better.

- Do you have a sectoral or thematic fund in your portfolio? Diversify, by selling them and switching to diversified funds, which invest across all sectors and themes.

- Do you have any investments that are locked in, other than ELSS? Examples of such investments are ULIPs, closed-ended funds, and interval funds. Don’t lock yourself in, unless you’re getting a unique advantage, like a higher return at lower risk than an investment you can find without a lock-in. This is rarely the case, so you should generally avoid locking yourself in.

- Do you have separate debt and equity funds for saving for retirement? You’ll pay less tax with a hybrid fund.

- Have you invested in a debt fund, in a dividend plan, whether payout or reinvestment? If so, you’re paying higher taxes than if you had chosen growth.

- Do you have more than 10 lac in a single fund? Is that at least 25% of your portfolio? If yes to both, diversify between funds. The fund manager can make a wrong decision, resulting in you retiring poor.

- Conversely, do you have a double-digit number of funds? That’s too many. You can’t track them and analyse them easily. Combine some investments.

- Do you have more than a lac in a bank account or FD? Move it to a mutual fund for better returns and lower tax.

- Have you invested all your money in India? Diversify away from a country that is only a few percentage points of world GDP. Investing all your money in one country is bad for the same reason investing all your money in one company or sector (mining, say) is.

- Do you try to invest when you feel the market is about to rally, or when a friend or newspaper article says that it’s a good time to invest? Don’t try to time the market — you will fail. Invest consistently every month, no matter what the market is doing.

- Do you redeem your investments if the market has declined? Do you realise that you’re buying high and selling low, losing money rather than making it? Don’t. The market keeps going up and down, say up to 60%. If you can’t handle that, don’t invest in equity in the first place.

- Do you track the market more than once a year? Don’t. The market keeps going up and down, and if you track it regularly, you will be worried when it declines and sell your holdings at a loss.

- Do you redeem often, like once a month on average? Don’t. Churning your investments will lead to low returns and high taxes and fees.

- When you get a dividend on your fund, do you spend some of it? Don’t.

- Have you combined investments and insurance, like a ULIP, a pension plan, or other insurance policy with a surrender value? Don’t. A investment-cum-insurance policy is non-transparent about returns and fees, often locked-in, and overall a worse deal than buying term insurance and investments separately.

- Even if you have a term insurance, is it from LIC? If so, you’re probably paying twice as much as a private insurer like ICICI. Switch to a private insurer.

- Did you buy an apartment? You’re going to make a pathetic return on what is probably the biggest investment of your life, be locked in to paying EMIs for ages, and be stuck to one apartment.

Hardly anyone knows all the above guidelines. A robo-advisor can ask all these questions, and when you answer yes to some of them, suggest remedial action, and even offer a button to execute the transaction then and there.

This is a better form of education than reading a book. Few people want to accumulate knowledge in the hope that it’s useful someday. People are more interesting in learning when they see an immediate benefit from learning, if it helps them achieve some goal they care about. Robo-advisories teach you what’s relevant to your financial situation, at the moment when you’re most willing to learn, and the minimum extent needed to take action.

And they teach you via an example from your real life rather than theory or an academic exercise, neither of which is interesting. For example, instead of saying, “Fees matter. They may seem like a small percentage, but they add up. Blah blah blah”, a robo-advisory might say, “Save 40K a year by switching to direct plans. Click here to execute the transaction.”

Robo-advisories done right are the best form of learning for most investors.

Things You Should Do

In addition to pointing out things you shouldn’t have done, a robo-advisor can check that there aren’t any blind spots in your financial planning, that you’ve taken care of all the aspects. These are again a sequence of questions with yes/no answers, but this time the right answer is yes rather than no. If you answer no, the site will tell you what to do about it:

- Do you have an emergency fund for six months’ expenses? If not, you should, before investing for the long-term.

- Have you maxed out your section 80C? If not, you should, since it’s free money. Consider investing in ELSS, since it has the shortest lock-in.

- Have you planned your retirement? When do you want to retire, how much do you need after retirement, and are you investing enough for it? Conversely, given how much you already have and are investing every month, when can you afford to retire, and how much can you afford to spend every month after retirement?

- Do you have medical insurance for at least 5 lac, covering all your family members? If not, get one.

- Do you have term insurance? If not, get one. Is it enough to fund your family’s living expenses? If not, get another policy.

- Do you have accident / disability insurance? If you meet with an accident and are unable to work for six months or a year, how will you take care of expenses?

- Do you have a SIP? You should.

- What fraction of your salary do you save? It should be at least 25%.

Conclusion

Robo-advisory can be extremely comprehensive, covering all aspects of your financial life — investments, insurance, retirement planning, emergency fund, the behavioural aspect of investments, and so on. It can be free or cheap, reliable, and cover everybody, the vast majority of whom are unwilling to pay tens of thousands of rupees every year.

Earlier, when we needed to withdraw money from our bank account, we had to go to the bank, fill out a withdrawal form, stand in a queue, present it to the teller, and get the money. Now, ATMs and debit cards have taken over — get your money any time of the day or night, at any ATM. In fact, you can pay a shop electronically without first withdrawing the money as cash and then handing over the cash to the cashier.

Robo-advisory will be the ATM of our time. One day, when we look back, we’ll think, why didn’t an automated system help you achieve your goals? Why didn’t it point out missing aspects of your financial planning, or flag and correct mistakes, helping you achieve your goals, living a prosperous and comfortable life?

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