Commentary: You may have noticed that there's a new trend sweeping the financial services industry: robo-advisers. What is a robo-adviser exactly? Is there actually a fleet of robots somewhere managing people's money?
Well, not exactly. They offer an online platform for investing and portfolio management and, despite the robo part of the name, humans actually are in fact involved. These services use algorithms to automate investing, manage individual portfolios and provide financial guidance. So, what spurned the rise of this new way of managing money? What do these advisers have that traditional (and might I add - 100% human) financial advisers don't? In the words of one robo-adviser: betterment.
Basically, behavioral finance shows that people aren't the best at saving or investing on their own. Furthermore, traditional advisers are usually only available to people with a certain net worth. Robo-advisers ostensibly try to eliminate both of these issues; first by the automation factor and second, by making their service available to people with smaller account balances. These organizations are using technology to offer financial help to many more people than traditional advisors ever could and they're doing it for a lower cost.
How exactly do robo-advisors work?
First of all, "automated investment services" is the official term for these services (robo-adviser is just a much catchier version). I'm sure you're familiar by now with online banking, automated savings, maybe even target-date funds, etc. Well, the same concept and similar technology is applied with this new service, except you're talking about investing rather than banking. Essentially, robo-advisers invest client money in diversified investment strategies, based on set algorithms and calculators that decide what is the best risk/reward profile for the customer. These services vary from how much human interaction is included. Typically, a higher-cost program offers, the more opportunity for involvement from an adviser over the phone or by email.
No longer are the days where you feel like you have to DIY and follow the stock market or have a lot of money to hire someone else to do it for you. The advent of robo-advisers is opening up an entirely new market to give people financial guidance. Take Learnvest's mission: "We believe financial planning should be affordable, accessible, and even delightful."
How do they differ from traditional financial advisors?
So, now that you know the basics, let's get down to it. Who might benefit from using a robo-adviser rather than a traditional adviser? What can this new technology do better than the tried-and-true model?
Cost: It's not a secret that traditional advisers generally make themselves available to investors at a certain income level. To be considered as a client by most fee-based advisors, you need anywhere from $200,000 to $2 million in investable assets or be willing to directly pay a few thousand dollars a year in planning fees. This really limits the amount of households that are entitled to personalized financial help. Since robo-advisers use technology to streamline their services at a lower cost, they make themselves available to a much wider audience. Depending on which service provider you go with, there may not even be a minimum balance requirement, but you will have to pay a monthly or annual fee.
Inertia: I've already mentioned the behavioral finance angle. Research shows that humans are bad at saving and investing on their own, for the most part. Just like you set up automatic deferrals into your 401(k) (or other retirement accounts) from your paychecks, a robo-adviser follows the same principal. You don't need to constantly monitor your investments, move money around, or set up a meeting with an adviser, it's all taken care of for you based on your appetite for risk.
One-trick pony: Robo-advisers are great if you have money you know you want invested in a diversified portfolio...and that's pretty much it. According to Michael Kitces, of the popular financial planning blog Nerd's Eye View, Robo-advisers are basically designed to do one thing: give you an asset-allocated passive strategic portfolio, he says.Thats the scope of what they do, period. If someone wants actual advice about anything beyond Give us your money and well invest your portfolio in a diversified manner, youre outside the capabilities of robo-advisers and into working with an actual financial adviser." Currently, there's no advice beyond that on topics like long-term planning, taxes, retirement, or Social Security.
Technology: It's widely discussed that millennials and forthcoming generations tend to widely embrace technology and automation. Their priorities are accessibility and saving time, not having a one-on-one interaction with a certified professional in a corner office. Millennials want to check their account balances on their mobile devices, not schedule a call with someone. In this sense, robo-adviser platforms are the natural step when it comes to the investment world and honing in on this audience.
Which robo-advisers should you consider?
While there are more robo-advisors sprouting up every day, here are some of the more well-known and more established names in the automatic investing world*:
- Motif Investing
- Personal Capital
- Rebalance IRA
- TradeKing Advisors
- Vanguard Personal Advisor Services
There's always debate when a new technology arises about its viability or whether it's even necessary and robo-advisers have not been immune to this. With that said, they're not for everybody. If you already have a general interest in managing investments or feel you can teach yourself, then you may be able to recreate what some of these services offer. Or, if you have more substantial assets and want personal advice tailored to your unique financial situation then robo-advisers won't fulfill those needs. If you have the funds and you don't know the first thing about investing it, don't have an interest or the time to learn and just want to see it grow, one of the robo-advisers out there might be for you. One thing that is for sure: these services beat what the average person is doing right now in terms of investing, which is typically nothing. From an adviser's perspective, we don't think robo-advisers will eliminate the traditional model. In fact, we think enhancements in financial services are good for competition and creating better products, tools and services for consumers.
*These are simply suggestions and we do not endorse any of these service providers. Proper due diligence is always required before engaging in a financial service or product.
Alex Assaley is lead adviser, retirement plans, with AFS 401(k) Retirement Services LLC in Bethesda, Maryland.
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