How to Compete with Online Advice: The Historical Lessons
October 21, 2014
by Dan Richards
Michael Mauboussin Tips From Great Investors [Pt.2]
This is the second part of a short series on Michael J. Mauboussin's research document reflecting on 30 years of Wall Street analysis published in 2016. Q3 2020 hedge fund letters, conferences and more The document outlined Mauboussin's observations of successful investors throughout his three decades on the Street. This article starts at point six. Read More
Online start-ups offering low-cost investment advice have received lots of attention, not to mention over $200 million dollars in venture capital. What lessons does history offer on the likely impact of online advice? And based on what’s happened in the past, how can advisors respond to this new threat?
Two reactions: Advocates versus skeptics
Reactions from observers of these start-ups, widely known as “robo-advisors,” fall into two categories.
Most industry observers scratch their heads in puzzlement. These sceptics see robo-advisors as a massive overreach by the tech community, similar to the failed experiments in the early days of the internet boom like Pet.com and Webvan. For example, a recent webinar by respected industry veteran Bob Veres pointed to businesses in the past that were seen as threats to advisors (such as discount brokers and Money Magazine) and proved to be non events. And Michael Kitces, among the best-regarded commentators on the investment industry, wrote an incisive piece on the robo-advice bubble deconstructing the economics of robo-advice and questioning how these could become viable businesses.
On the other side of the argument are the tech proponents, who view online advisors as transformative players that will use technology to lower costs, improve client outcomes and alter the playing field for financial advice. These observers see the new firms as having the same effect on financial advice as Amazon has had on the sales of books – increasing convenience, lowering prices and putting incumbent competitors under pressure. Typical of this thinking are recent New York Times articles on advice for people who aren’t rich and sites to manage personal wealth gaining ground and one from the Wall Street Journal on how to get advice online for less.
So what does history suggest about the likely outcome of these new entrants? Are the advocates or the sceptics closer to the mark?
Lesson One: It will be harder and take longer than the advocates believe
Given the power of inertia in maintaining the status quo, history suggests that it will take longer (perhaps much longer) for robo-advice to get traction than most promoters and advocates believe. That’s especially the case given that most assets today are held by older clients, the least tech-savvy and the most resistant to change.
As a result, chances are good that many of the initial investments in these start-ups will end in tears. Railroads offer an instructive example. After they first appeared on the scene in the early 1800s, there was a huge railroad boom from the 1830s to 1860s, in which railroads displaced canals in moving freight. It’s hard to underestimate how instrumental railroads were in helping enable two centuries of remarkable economic growth. At the same time, most of the early investors in railroads were wiped out – simply because the initial optimism fuelled overinvestment and overcapacity, leading to consolidation and a shakeout. The same thing happened to early internet players like Global Crossings and Tyco. In the 1990s, they spent billions to lay fibre optic cables in anticipation of an explosion of internet traffic and then ran into financial difficulty because they weren’t prepared for how long it would take demand to materialize.
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