Oversimplification and one-size-fits-all solution given by robo advisors doesn't work
Of late, there has been a lot happening in the mutual fund space. Whether it is reduction in the total expense ratio (TER) in mutual funds or advent of robo advisors who are offering direct plans. Flushed with private equity funding, direct robo advisors have raised the marketing pitch to such a level that every investor feels that this is the next best thing to buttered bread and they will actually have ₹ 25 lakh more in 25 years. While I totally support the direct plan, I am not sure that even 5% of the existing customer base today can manage their investments DIY.
The robos, typically, ask you a set of questions to decipher your risk profile, goals and suggest some plans based on your answers. This is an investment plan for the current money that a person wants to invest. This is not a financial plan. Giving an investment plan is easy but developing a financial plan involves too many elements and future thinking that an individual may not even have even thought of. An investment plan will just tell you where you can invest for your goal whereas a financial plan takes into account all your needs and wants and gives you direction on what is achievable, apart from giving suggestions on how the plan can be implemented. A financial plan is for life whereas the investment plan is for a certain amount of money.
A big variable, which a platform cannot assess is investment behaviour, which is a huge determinant of investment success. The markets have had a great run in the last few years but if there is a prolonged downward movement, I don’t see most DIY investors holding on to their investments. I regularly meet retail investors who are investing into equity systematic investment plans (SIPs) with 2-3 years timeframe. I am not sure how platforms intend to influence the right investment behaviour, which is key for customer retention.
Further, there is a point till which investors can go DIY. At the start of one’s financial life, it is easy to use such portals but as life events happen and one has a more complex financial life with borrowing, longer financial goals and more needs, one certainly needs a human interface. It’s like filing your tax returns yourself during your early working years. But as you grow older and have capital gains etc. coming in, you would need the help of a chartered account.
There are some inherent issues with DIY platforms:
One size fits all: Most platforms have certain bundled solutions based on your risk profile and goal horizon. As an advisor, I have never really believed in risk profile questionnaires simply because investors never end up following the recommended asset allocation. A person’s risk profile is more about their ability to take risk than their need to take risk. Even if an investor needs to invest 70% into equity to be able to reach his goal, he will not do it unless he can stomach that risk. Hence, the oversimplification and one-size-fits-all solution doesn’t work.
Recommendations: Having looked at the fund recommendations, I find small-cap/thematic funds, which are the top performers over the last three years there. I do not believe that these funds are suitable for first-time investors. At best, these funds should be only 5-10% of an individual’s portfolio. I also find smaller sized funds which may not have a long track record. Further, schemes from all fund houses are not offered (which is okay as long as well-performing schemes are not left out).
Inflation and return on investment (ROI): These are the two important numbers used to calculate the future value of a financial goal. If these are not forecasted in line with investor behaviour, there would be a big mismatch between what the investor expects to make and will end up making. In my financial planning sessions, the biggest mistake investors make is to expect 15% ROI whereas their investments would actually be giving them 8% per annum weighted average returns.
Costs: Finally, nothing comes free. How many investors actually read the terms and conditions on the platforms. My understanding is that the platform can offer you free advice because it is PE-funded. But what happens if it is not able to scale up and the PE funding stops? Investors need to beware on how their data is used. One of the robos’ terms and conditions mentions that they will be using the data for market research and cross-selling.
So what do customers need to do?
Don’t blindly trust: Just because an advisor mis-sold products, online platforms may not be the panacea. Most robos have come up while markets are doing well and hence there is no proof that their recommendations will do better compared to the traditional advisor. One of the robos advertises its recommended plans with the average return over the last five years and how long it took money to double, which should not be the criteria to choose funds. Be informed. Read up. Remain invested as per your goal, whether it is an advisor or a robo’s call centre asking you to switch your equity investments in a short time.
Start paying for advice and use technology: You may consider hiring a financial planner to draw up a holistic financial plan and then use transaction platforms to invest. This way you have the best of both.
On their part, if robos are really in this business for the long term, they need to focus on having the right messaging which could be more educational in nature rather than just focusing on the convenience their platform provides, as wealth management is not only about algorithms but also a lot about behaviour. Remember technology can be an enabler but not an end in itself.
Mrin Agarwal is a financial educator, founder director of Finsafe India Pvt. Ltd and co-founder of Womantra
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