Robo-Advisors: A sublime confluence of Artificial Intelligence and Behavioural sciences
This article is a part of “ AIBS — A Great Confluence series” covering all tools and products which leverage best of Artificial Intelligence and Behavioural science to help humanity to lead better and joyful lives.
What exactly are these Robo-advisors? Imagine you’re planning a cross-country road trip. You have a destination in mind, but you’re not quite sure which route to take or where to stop along the way. You could ask your adventurous friend for advice, but they might have their own biases and preferences. What if you had a reliable Auto/Co-pilot who could analyze all the maps, weather conditions, and road traffic data to suggest the best route and pit stops? That’s exactly what a robo-advisor does for your investments!
Just like a co-pilot, a robo-advisor is a digital companion that helps you navigate the world of investments. It’s like having a knowledgeable friend who understands the ins and outs of the financial landscape. You share your goals and preferences with the robo-advisor, and it uses its super-smart algos and behavioral insights to guide you towards the best investment decisions or make customized investment plans.
Let us consider the utility of these Robo-advisors:
Available 24/7: Robo-advisor is like your personal financial advisor who is available 24/7, doesn’t get tired, and always has your best interests in mind. It’s like having a financial expert in your pocket, available anytime you need.
Personalisation: Whether you’re saving for a dream vacation, planning for retirement, or simply growing your wealth, Robo-advisor is there to provide personalized advice and manage your investment portfolio. They deeply personalise your investment plans by analysing your financial needs, risk tolerance, and preferences. By leveraging AI they can offer a plethora of choices and sequence recommendations for you.
Objectivity: Robo-advisor instead of relying on intuition or gut feelings, use super-smart algorithms to crunch numbers and make data-driven decisions. It’s like having a team of financial experts working tirelessly behind the scenes to optimize your investment strategy.
Pocket-friendly: Robo-advisors are almost always pocket friendly. They are very inexpensive when compared to their human counterparts. Even the minimum investment size to sign-up for the services is much lower when compared to having a human financial advisor.
Dynamic Recommendations: Markets are unpredictable and dynamic. Robo-advisors by factoring your risk profile objectives and time horizon, it is capable of automatically making adjustments along the way, rebalancing your portfolio, or suggesting changes based on market conditions.
You may be wondering how practical and accessible are these Robo-advisors; let me say — they are here and now. Several companies have emerged as leaders in the robo-advisory space, leveraging behavioural finance principles to nudge investors towards better financial decision-making. Let’s explore a few prominent Robo-advisors globally:
Betterment — Simplifying Decision-Making:
Betterment has integrated behavioural insights into its platform to simplify decision-making for investors. By applying the principles of prospect theory, Betterment nudges investors to focus on their long-term goals rather than short-term market fluctuations. Their intuitive user interface presents complex concepts in a user-friendly manner and provides personalized recommendations based on each individual’s risk tolerance and financial objectives.
Scripbox — Leveraging Default Options:
Scripbox utilizes default options and choice architecture to guide investors toward prudent choices. For example, their platform automatically can invest periodically or reinvests dividends, or rebalances portfolios by default. This nudges investors to stay the course with their desired asset allocations and removes the burden of decision-making, reducing the impact of emotional biases.
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Wealthfront — Addressing the Loss aversion need:
Wealthfront’s algorithms continuously monitor investment positions for tax-loss harvesting opportunities. Whenever there is a loss exceeding a certain threshold, the robo-advisor triggers a sell order to harvest the tax loss. However, to address the behavioral bias of loss aversion, Wealthfront automatically replaces the sold investment with a like, but not exact, asset to maintain the overall portfolio allocation. This approach allows investors to avail the tax benefits while reducing the emotional impact of completely divesting from the investment.
Acorns or Jar — Encouraging Regular Saving:
Both Acorns and Jar employ a behavioral finance technique known as “round-ups.” The platform automatically rounds off users everyday purchases to the nearest dollar and invests the spare change. This nudges individuals to save and invest without requiring substantial effort, making it easier to accumulate wealth over time. Acorns address psychological barriers and promote a savings and investment mindset. This innovative approach has attracted a considerable user base, especially among more youthful demographics.
Niyo (Goalwise) —
Goal-Oriented Investing: Niyo combines behavioral finance principles with goal-oriented investing. This platform encourages investors to define specific financial goals and tracks progress toward achieving them. By setting clear targets and providing ongoing feedback, Niyo nudges investors towards disciplined and purpose-driven investment strategies.
Now, let us look at how these Robo-Advisors have captured and performed in the market, these past few years.
Robo-advisors have gained significant traction in recent years, providing individuals with effortless access to proficient investment advice and portfolio management at a fraction of the cost traditionally associated with human advisors. These platforms have democratized investment management, allowing even small investors to benefit from sophisticated strategies previously available only to high-net-worth individuals.
This has meant the Robo-advisory industry has experienced explosive growth in recent years. According to a report by Statista, assets under management (AUM) by robo-advisors worldwide are projected to reach a staggering $1.4 trillion by 2023, and a report by ‘Grand View Research’ projects a compound annual growth rate (CAGR) of 33.5% from 2021 to 2028. Not only is the industry growing in size, but these studies have also shown that investors are increasingly embracing robo-advisors. A survey conducted by Deloitte found that 45% of respondents expressed confidence in robo-advisors’ ability to deliver higher returns than traditional advisors.
What does the future hold?
As you can see, we are currently in phase 3.0 and with the rapid development of artificial intelligence, we are quickly moving to phase 4.0 of Robo-advisors. In stage 4.0, Robo-Advisors would be fully automated and self-learning, further reducing costs and optimising the fee structure.
In addition, experts predict that a hybrid Robo-advisory model combining the best of traditional and digital services will soon become mainstream. These are essentially robo-advisors powered by AI and ML with the ability to interact with human advisors at various points. Take Charles Schwab’s Robo-Advisor, as an example, which offers the ability to negotiate with human advisors by combining the efficiency of AI-based algorithms with the guidance of experienced professionals.
In conclusion, Robo-advisors represent a pioneering paradigm in investment management that combines the power of AI-driven algorithms with behavioral finance principles. As demonstrated by companies such as Betterment, Wealthfront, Jar and Scripbox, robo-advisors effectively use artificial intelligence and nudge techniques to optimize investment decision-making. Thanks to continued advances in technology and behavioral insights, the future of Robo-advisory, holds tremendous potential, ultimately benefiting both businesses and individuals seeking to achieve their financial goals.