Due to the proliferation of new computer-assisted advisory platforms, it’s natural to ask what investment advisers of the future will look like and whether they’ll be humans or robots.
A fast-growing segment of the investment advisory market focuses on providing low-cost advisory services using high-tech advancements. These platforms use computer algorithms to determine appropriate investment products and optimal portfolio composition and then use the internet to deliver information to clients.
These new entrants are commonly referred to as robo-advisers, although some prefer the term “algorithmic investment services.”
Some of these platforms, such as Betterment, Wealthfront, and LearnVest, are building a significant client base and have recently raised a notable amount of venture capital. This is an indication that computer-assisted investment advice and financial planning is a sustainable business model that has already gone mainstream.
Opportunities and Drawbacks
These companies fill a need by giving an under-served part of the market, clients who cannot afford or attract the services of traditional providers, access to financial advice.
Many companies in this space assure investors that they can provide services equal to or better than those of traditional financial advisers at a much lower price point: They advertise fees of 35 bps or less on total asset value because they have reduced or eliminated many fixed costs (labor, rent, etc.) and have automated a number of their business processes.
Replacing people with processors is what fuels the chief and most pertinent criticism of these platforms, which is a perceived inability to customize advice. Many believe that each investor is unique and that his or her individual financial goals, risk preferences, and investment constraints are too complex to be effectively captured by a computer.
These companies take a one-size-fits-all approach to analyzing client needs, which is then used as the basis for investment planning and ongoing financial advice. For example, Wealthfront has a 10-question tool that may not offer a complete assessment, and Betterment merely asks its clients questions about their risk tolerances and goals, which for many are hard to objectively evaluate.
It seems possible that an algorithm could determine a person’s financial ability to take risks, but an algorithm is assuredly less effective than a human practitioner in determining a client’s emotional ability to take on those same risks. Because investor behavior and behavioral biases will have a direct influence on investment decision making, the inability to determine these traits could be problematic.
What Product and for Whom?
These platforms try to mitigate concerns by focusing on individuals with smaller-than-average account sizes, who historically have not had access to investment advice. People without a significant amount of capital are not often in need of complex portfolio strategies or investment products.
Some of these companies are focusing solely on financial planning and helping clients develop fiscal discipline. Another strategy is limiting investment strategies and financial products to passive ones, such as index funds and exchange-traded funds. By restricting clients to taking only market risk, online service providers can offer simple but suitable investment services at the lowest cost available. By targeting high volume, there is the possibility that the providers will find a sustainable business model despite low margins.
As start-ups, some companies originally targeted younger clients because of their trust in technology and comfort with receiving a multitude of services online. Wealthfront, which has amassed more than $800 million of assets under management (AUM) and recently surpassed both Betterment ($360 million) and Personal Capital ($200 million) to become the largest of these advisers, says that more than half of its clients are 35 years old or younger (85% are under 50). But Wealthfront, because of its almost-exclusive focus on upwardly mobile tech professionals in Silicon Valley, may not adequately represent the rest of the tech-assisted advisory market.
In order to develop a competitive advantage and diversify product offerings, some advisers are bundling other financial services, which is also helping them to broaden their customer base. Betterment has attracted older clients by providing a service to reduce longevity risk by determining a safe amount that clients can withdraw from their accounts each month. Wealthfront and Future Advisor are providing tax-loss harvesting performed throughout the year in an attempt to optimize their clients’ portfolio returns.
Full-service financial planning, including personal finance tools, is also included with certain platforms. In fact, there is a focus on delivering basic, intuitive, easy-to-understand financial planning, instead of on complicated or customized investment strategies. The goal is to direct, limit, or change client behavior so that individuals abstain from irrational decision making and instead follow a more appropriate and rational financial plan.
Are These Platforms Changing the Market?
During a panel at this year’s CFA Institute Annual Conference, Fortigent’s Chief Investment Officer Scott D. Welch discussed the competitive challenge that these services may pose for traditional investment advisers in the long term. Although they do not currently present an obvious competitive threat for traditional advisers, they soon may, as individuals from Generation X and Millennials come to make up the majority of advisory clients.
In addition to being comfortable receiving computer-assisted services online, according to Welch, these younger generations “speak technology. . . . It is their native tongue. If you can’t speak to them using that medium, it’s going to be a hard row to hoe.” He also counsels,”What you better be prepared to do as an adviser is have a good answer when they walk in the door and say your proposal looks a lot like this one that is going to cost me 10 bps, so why are you charging 1%?”
In terms of business and market development, it is difficult to argue that computer-assisted investment advice is not a mainstream and growing trend. Well-known traditional advisory companies have entered the market, and traditional advisers can broaden their service offerings by adopting similar methods.
Vanguard has recently started a pilot program (Personal Advisor Services) to assist people who want to make their own investment decisions. Although Vanguard’s fees (30 bps on account value) match competitive programs, their minimum $100,000 account requirement (if successful, to be reduced to $50,000) is still out of reach for the multitude of investors.
But Vanguard’s reaction to their client’s requests for ongoing advice and hand-holding with a low-cost service delivered online indicates that Vanguard believes that a significant group of clients would prefer to receive financial advice in this manner.
These new platforms are finding markets in other countries as well. The United Kingdom has had Nutmeg for a while, and Canada, a country known for having higher-than-normal fees on financial products, has just seen the launch of a new low-cost provider, Nest Wealth.
Business News Network host and Nest Wealth founder Randy Cass, CFA, says, “Nest Wealth gives investors a choice that lets them both rest easy and keep a lot more of their money in their own pockets. Everything being done at Nest is built off of the concepts that large institutions have been using to manage their money for decades, so why shouldn’t individuals be given the same opportunity?”
Although there is little question that they are here to stay, the big question facing these platforms is