Algorithms are capable of quite a lot in 2016. Match Group (ticker: MTCH) algorithms help people date; Tesla Motors ( TSLA) algorithms help people drive; Spotify helps people discover new music, and now robo advisors can help diversify their portfolios.
Robo advisors are automated online tools that can make investment suggestions, manage money, routinely rebalance portfolios and even make savvy trades to minimize taxes. And they’re becoming more and more popular each day.
Wealthfront and Betterment, the two most-recognized robo advisors, already have billions of dollars in assets under management. A.T. Kearney estimated the industry as a whole manages about $30 billion now, but sees that going parabolic in the coming years as investors entrust more than $2 trillion of their hard-earned money with robo advisors by 2020.
But what could possibly motivate investors to throw so much dough behind this new, relatively unproven wealth management philosophy?
[Read: Why the ETF World Could Double by 2021.]
The answers: dirt-cheap fees, simplicity and the quest for better performance.
Typical asset-based management fees for financial advisors often run in excess of 1 percent annually, and requiring a minimum investment of $50,000 or more is also pretty standard.
Some robo advisors, by contrast, don’t even have minimum buy-ins. Wealthfront manages the first $10,000 for free. It charges 0.25 percent on everything after that. Betterment has tiered fees: Balances of less than $10,000 cost 0.35 percent annually, $10,000 to $99,999 costs 0.25 percent and $100,000 and up will only run you 0.15 percent.
Just hand over your money, tell the robots a little bit about your risk tolerance and goals and leave the rest to the algorithm. You’ll be invested in passive ETFs, and your portfolio will systematically rebalance when it’s time.
So how are these machines changing the money management landscape? Clearly, old-school financial advisors are the ones with the most on the line.
Brian Barnes, founder and CEO of M1 Finance, an online brokerage that allows you to create, organize and automate an investment portfolio, thinks financial advisors should prepare for a reckoning.
“If all they’re providing is asset allocation and they’re trying to charge 1 percent for that, you can get that anywhere for a quarter to a third of the cost, so there’s going to be some cost pressure there,” Barnes says.
“The traditional financial advisor model is under assault,” says Michael Spellacy, PwC global wealth management leader.
The rise of the cheaper, less restrictive robos should leave financial advisors looking for ways to improve. “The financial advisor has to ask themself the question: ‘What is my differentiation to my customer? How will I be a better financial advisor to my customer?'” Spellacy says.
Barnes, for his part, sees two ways advisors can combat the onslaught of robo advice.
“Either costs are going to plummet or you’re going to see a sort of renaissance in the sort of offerings that financial service providers need to give you,” he says.
Robos can’t do everything. That said, it would be intellectually dishonest to pretend money-managing robots can do all the same things that human financial professionals can do.
“Our [registered investment advisors] are really more comprehensive wealth managers — like financial life coaches — than just focusing on the investments that a client has,” says Tom Nally, president of TD Ameritrade Institutional.
[See: Battle for Supremacy: Robo-Advisors Versus Financial Advisors.]
Nally says the professionals he works with provide about a dozen different services to clients, many of which simply can’t be performed well by a robo advisor in this day and age. Estate planning, financial life planning, refinancing a mortgage, how to structure a small business, whether to hold properties in a trust — “investment management is just one component,” Nally says.
Robo advice is certainly here to stay, and it has its place in the wealth management landscape of tomorrow. But it’s just a fact that there are some crucial things robots can’t do, not least of which is providing that emotional reassurance and human touch.
“That steadying hand, and that steadying influence, is a very important part of the markets. So when everybody floods into robo, if the market suddenly goes down, the question is: ‘What if?'” Spellacy says. “What if it all collapses — how do you react? Will you be able to get out fast enough? Will the robos be able to help you to make that happen? Nobody knows yet, right?”
Hybrid model. Robots, with their limited range of financial service offerings and their interpersonal shortcomings, and human financial advisors, with their high fees and inflexibility with small accounts, have their flaws.
That’s why many see the asset management landscape changing to allow for the best of both worlds with a hybrid model: part robo-advisor, part real financial advisor. Vanguard, for instance, has already designed a product that melds robo advice with real-world expertise and low-cost access to an actual financial advisor.
The hybrid model, says Nally, “is the model of the future.”
Takeaways. At the end of the day, it’s really tough to argue that the robotization of financial advice isn’t a net positive for the individual investor. While investors should be careful not to be lulled into a sense of complacency and wooed into products that they don’t really understand, the renewed pressure on human advisors to either lower fees or increase value-added services is a big win for the little guy.
[Read: Wealth Management Tools for the Not-So-Wealthy.]
The digitization of money management is underway, and there’s no looking back now.
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How Will Robo Advisors Impact the Future of Investing? originally appeared on usnews.com
