The Motley Fool

Will Robo-Advisors Eat the Big Banks’ Profitable Lunch?

It’s no secret that Canadians pay a hefty premium when saving their money. Mutual funds often come with fees of 2%+ per year, among the highest in the world. Registered accounts often come with administrative fees. And if you want to trade stocks yourself, you may still end up paying $25 per trade.

For this reason, the wealth management industry is ripe for disruption. Enter the so-called robo-advisors, who are providing us with a lower-cost alternative. So, what exactly do robo-advisors do, and how worried should banks like Royal Bank of Canada (TSX:RY)(NYSE:RY) and Toronto-Dominion Bank (TSX:TD)(NYSE:TD) be?

What do robo-advisors do?

To put it simply, robo-advisors provide a technology-based solution for investors, one that is simple and low cost. All told, investors should expect to pay between 0.6% and 1% in fees every year.

How is this possible? Well for one, robo-advisors use exchange-traded funds, rather than mutual funds. So, robo-advisors don’t need to pay anyone to pick stocks. They also don’t need to compensate an investment advisor, since asset allocation is done automatically.

Why the banks should be worried

Banks simply can’t offer this kind of product. They rely on big fees from mutual funds to support their portfolio managers and wealth advisors, not to mention their expensive branches. And mutual funds typically aren’t able to outperform exchange-traded funds. So, there’s very little stopping robo-advisors from taking the banks’ business.

Why the banks will be fine

Let’s not get carried away here. The banks still have the upper hand in the wealth management industry for a number of reasons.

To start with, investors often have a strong relationship with their financial advisor. These relationships often last for many years, and breaking this relationship is very difficult.

Secondly, Canadians generally trust their banks, and for good reason. They are viewed as big, stable, money-making machines. They’ve been around for more than a century. They’re subject to strict regulation. And even if they fail, they’ll probably get bailed out.

Robo-advisors are much newer and are viewed as a riskier option. In actual fact, there really isn’t any increased risk. All your savings (up to $1,000,000) are protected through the Canadian Investor Protection Fund, and robo-advisors can’t use your money to cover their operating expenses. Yet this trust gap may be too hard to overcome.

But there’s another reason why the banks will be fine: a lack of transparency. Too many Canadians simply don’t realize how much they’re being charged for investing their money, and don’t understand how much they can save by switching to a robo-advisor.

So, if you’re investing in a Canadian banks’ shares, you shouldn’t concern yourself with robo-advisors. But if you’re investing in their mutual funds, then robo-advisors are certainly worthy of your attention.

Just Released! 5 Stocks Under $49 (FREE REPORT)

Motley Fool Canada's market-beating team has just released a brand-new FREE report revealing 5 "dirt cheap" stocks that you can buy today for under $49 a share.
Our team thinks these 5 stocks are critically undervalued, but more importantly, could potentially make Canadian investors who act quickly a fortune.
Don't miss out! Simply click the link below to grab your free copy and discover all 5 of these stocks now.

Claim your FREE 5-stock report now!

This article represents the opinion of the writer, who may disagree with the “official” recommendation position of a Motley Fool premium service or advisor. We’re Motley! Questioning an investing thesis — even one of our own — helps us all think critically about investing and make decisions that help us become smarter, happier, and richer, so we sometimes publish articles that may not be in line with recommendations, rankings or other content.

Fool contributor Benjamin Sinclair has no position in any stocks mentioned.

Two New Stock Picks Every Month!

Not to alarm you, but you’re about to miss an important event.

Iain Butler and the Stock Advisor Canada team only publish their new “buy alerts” twice a month, and only to an exclusively small group.

This is your chance to get in early on what could prove to be very special investment advice.

Enter your email address below to get started now, and join the other thousands of Canadians who have already signed up for their chance to get the market-beating advice from Stock Advisor Canada.