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Robo-advice has become a key buzzword in the financial and technology industries recently. Robo-advisors are digital wealth management platforms that provide automated financial planning services and investment solutions mostly based on passive and cost-efficient instruments, while efficiently managing these allocations by rebalancing mechanisms. In this study, we compare and estimate the costs between traditional investment advice and robo-advice solutions.
The authors compare robo-advice solutions with traditional investment advice on three key levels. First, robo-advisors provide mostly passive market access with strategic asset allocations (SAAs) versus traditional investment advisors offering active market calls.1 Second, robo-advisors guarantee cost-efficient implementation with exchange-traded funds (ETFs) versus traditional investment advisors who invest mostly in actively managed funds. Third, the authors consider potential behavioral biases among investors with a robo-advisor solution versus a traditional investment advice solution.
The authors empirically show that robo-advice investors save over 4% a year in direct and indirect costs compared with traditional solutions, such as advisory fund solutions at banks or asset managers, because robo-advisors offer more efficient solutions on all three key levels.
The article is structured as follows: first, we will discuss the importance of passive investing with strategic asset allocations and advantages of robo-advice. Then, we describe how robo-advisors implement investment strategies in a cost-efficient way. The next section describes the behavioral gap that arises when not sticking to a long-term investment strategy, follwed by an empirical section that quantifies the difference in costs between robo-advisors and traditional advisory solutions. The last section concludes.
ADVANTAGES OF ROBO-ADVICE
Active investment strategies are often expensive and do not, on average, deliver real added value for investors in the context of diversified market exposure. Today, about one-third of the share of outstanding equities is held by passive investors, and they are projected to control half of the U.S. stock market by 2021.2 Robo-advisors might add to that development.
The strategic asset allocation--that is, the mix of asset classes that determines the investment strategy's exposure to systematic risk--is the most important investment decision of a long-term investor who seeks diversified market exposure. A key aspect of successful long-term investing is to define a robust and well-diversified asset allocation across a global universe of asset and sub-asset classes. Furthermore, an investor should capture different risk premia,...