Human or Software: Which is the Better Bet to Manage Your Stocks and Shares ISA?
If you are a beginner investor, the chances are that you won’t be brave enough to take the decision to put all of your ISA funds into shares you have picked out yourself. And unless you are a particularly precocious talent in stock picking, that’s probably a wise move. For most, putting together a well-balanced and diversified stock market portfolio that will deliver consistent average returns over years and decades is a skill that takes years and experience to acquire. It also means devoting a considerable amount of time to research and analysis on an ongoing basis. As is well documented, even the majority of professional fund managers fail to consistently beat the market – the overall performance of a major index like the FTSE 100 or FTSE All-share.
In most cases, the better approach for beginners is to entrust the job of building a diversified investment portfolio to the experts, even if they are not infallible. Some good research will also turn up the investment managers that do manage to consistently beat the market. They are out there. However, actively managed funds come at a price because good fund managers aren’t cheap. Actually, even the bad ones aren’t cheap. That means however well actively managed funds do, that price eats into investment returns.
However, over the past few years, a tech-based alternative has come to market – robo advisors. Robo advisors take you through an online questionnaire which profiles you as an investor type based on your personal financial circumstances, investment goals and timelines. You are then offered a diverse and balanced portfolio that is usually built from inexpensive ETFs, which passively track different markets. This is put together and adjusted periodically by a combination of software-based algorithms and expert human oversight.
As an investment guide for beginners on the advantages of man against machine when it comes to effective ISA portfolio management, what are the pluses and minuses of robo advisors and fund managers?
Cost: between platform fees and modest ETF fees, a stocks and shares ISA portfolio held with a robo advisor should be expected to come in at between 0.65% and 1% of overall value annually. Actively managed funds charge an average of around 1.5%. The investment platform you have your ISA with will also charge another 0.2% to 0.5%, putting the total cost at between 1.5% and 2% annually. So on cost, robo advisors win. That 1% difference equates to £1000 a year on a £100,000 portfolio and even if yours is smaller hopefully in a few years it won’t be and annual fees also mount up over the years.
Performance: unfortunately, this is the tricky part to gauge because robo advisors have not been around long enough to judge their performance during a serious market downturn. The main companies on the UK market such as Nutmeg, Wealthify, MoneyFarm and Scalable Capital have been around for 6 or 7 years at most (Nutmeg, the oldest, was founded in 2011). As such, while their robo advisor portfolios have done well in comparison to managed funds over the past few years, the real test is yet to come.
The problem with ETFs the passively track indices is that when the going is good in financial markets, they do well by default. However, when markets plunge, it is an active fund manager’s job to pre-empt that and also react while it is happening. Losses will almost certainly be sustained but if the fund has been put on a more defensive footing, and also adjusted while markets drop, they will hopefully be limited. An active fund manager should then again readjust to make the most of the upward swing when markets recover.
Robo advisors do, in theory, balance portfolios, especially the more conservative options available, to protect them against a serious market downturn. However, in the years since they came to market, that hasn’t yet been properly tested so it’s difficult to predict how they will fare with less active human input.
That’s the trade-off. Robo advisors win on cost but there is an unknown quantity in how robust their portfolios will prove to be in the kind of negative market conditions they have yet to have to navigate.
Please remember that financial investments may rise or fall and past performance does not guarantee future performance in respect of income or capital growth; you may not get back the amount you invested.
There is no obligation to purchase anything but, if you decide to do so, you are strongly advised to consult a professional adviser before making any investment decisions.