Robo-Advisors Are Not New – But They Foretell the Future of Financial Advice

February 17, 2015

by Joe Tomlinson

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So-called robo-advisors have been heralded as the next generation of technology that will transform the financial advice industry. Underneath the considerable debate that has emerged over their potential impact, an obvious fact has been overlooked: Much of what they offer is distinctively “old school.”

Some foresee major disruption, while others predict that the trend will support an expansion of the existing business model. By looking at what is truly innovative about robo-advice – versus what is merely a repackaging of what already exists today – I’ll assess the near-term future and what to expect over the next 10 to 20 years.

Recent history

There has been growing recognition that the financial advice business concentrates on an older population with considerable wealth. Those who are younger and in the early stages of accumulating wealth represent a huge underserved market. Silicon Valley employees exemplify this potential market, and it’s no coincidence that new robo-advisor firms are based there and receive venture capital support from local investment firms. The new robo-firms include Betterment, Future Advisor, LearnVest, Personal Capital, SigFig, and WealthFront. These firms typically offer automated services for asset allocation, rebalancing and, in some cases, tax-loss harvesting. Even more importantly, they offer user-friendly platforms so that clients can easily stay in touch with their investments.

Bigger firms are also entering the competition with Vanguard and Schwab both offering low-cost advice services. The big firms are also exploring partnerships with the robo-firms and looking for ways not only to serve clients directly, but also to bring the power of automation to their advisor networks. The leader in the partnership game is Fidelity; they have formed partnerships with Betterment and LearnVest and also acquired the financial software firm eMoney, all with a focus on providing enhanced capabilities to their advisor network.

This is an extremely fluid business environment as participants are moving quickly to gain first-mover advantage.

Not leading edge

One might get the impression that we are witnessing leading-edge technology applied to financial advice, similar to advancements in driverless cars, machine learning and smart robots.

But the reality is that the robo-advisor developments remain distinctly old-school.

The automation of rebalancing and tax-loss harvesting involves straightforward rules-based processing. Asset-allocation recommendations reflect the combination of passive investment strategies made popular by Vanguard beginning in the 1970s and mean-variance optimization invented by Harry Markowitz in the 1950s. Although the robo-advisors have generated a lot of strategic rethinking and increased the pace of change in the advice business, they don’t incorporate the newest developments in technology.

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