The Rise of the Robo-advisor

Robo-advisors, offering automated investment services at relatively low cost, have been a big hit with millennials and smaller investors, ever since they first appeared in 2008. The sector has seen impressive growth in recent years, as more investors shift towards passive management strategies. These automated investment platforms, also known as “robos”, have positioned themselves as an alternative to active management, with the promise of delivering all the advantages of a human investment advisor without the emotional weaknesses and high commissions.

Rapid growth and evolution 

In 2016, the largest Robo-advisors in the U.S. reached around $60 billion in total assets under management, according to Sanford C. Bernstein & Co LLC. This might seem like a drop in the bucket when compared to the nearly $70 trillion asset management industry, but a forecast by A.T. Kearney predicts that the funds managed by robos could grow to $2.2 trillion by 2020.

robo advisors

Their success so far has often been attributed to their ability to recommend and offer asset-allocation models for a low minimum investment and at a very low fee. In their original marketing approach, robos targeted millennials and smaller investors, typically with little money to invest and limited or no prior investment experience.

However, the market for these products is no longer confined to this demographic. Leaders of the robo-advisory industry, like Betterment LLC and Wealthfront Inc., are also boasting wealthier clients. More than half of Betterment’s $3.3 billion of assets under management comes from people with more than $100,000 at the firm, according to the company’s spokeswoman, Arielle Sobel. As for Wealthfront, more than one-third of its almost $3 billion in assets requires accounts of at least $100,000.

Big Banks: If you can’t beat them, join them

Overall, big banks and established wealth management firms have been slow to adapt to this changing landscape. Nevertheless, they are now responding to the threats posed by the robos and other online investing platforms. Through partnerships and mergers, they are digitizing their services, expanding their existing online platforms and offering rival products of their own.

UBS recently teamed up with SigFig Wealth Management, a California-based start-up, to develop new online management tools, while Wells Fargo revealed plans to release a robo product within the year, also as a result of a SigFig partnership. Merrill Lynch announced it will be rolling out its own robo service and app in early 2017. JPMorgan Chase CEO Jamie Dimon, went a step further, saying that not only could his company build a competing product, but they could also “give it away for free, if we want.”

Perhaps this shift is also encouraged by the documented success of Charles Schwab, one the first to jump into the robo fray. After releasing its first robo in 2015 and seeing its assets under management explode more than $5 billion within a year, the company recently announced plans for a second one, to be launched in 2017.

Limitations and risks

Robo services are based on simple client-discovery questionnaires which serve to establish the investor’s risk tolerance and goals. The company’s software then combines the answers with various rules of thumb and basic investing principles in order to determine the appropriate asset allocation model.

This convenience of a quick and easy assessment process does, however, come at a cost. With some robos asking as few as four questions, their main weakness against traditional investment advisors becomes apparent. Investing and financial planning involves complex and multi-factor decisions that require more than a basic questionnaire. Thus, such superficial assessments often fail to capture the entirety of an investor’s needs and goals, in the context of their specific circumstances.

Consequently, while robos can help with some decisions, based on this basic risk profile and rules of thumb regarding asset allocation, most of them cannot offer truly tailored advisory services. The information they collect and the generic principles they apply might work for simple investment decisions, but do not suffice to handle more complex scenarios like tax-optimization, individual saving plans and goals, or major life and family changes.

The human touch

The main advantage of a human advisor is the fact that they are emotional, the very argument that the robo companies use against them. Emotions, and empathy in particular, helps them understand their clients’ needs and goals, beyond self-reporting assessments. They know the right questions to ask and can guide an investor to adapt and adjust his goals, according to their individual circumstances.

Additionally, they can manage their clients’ emotions and help them get through difficult situations. They can protect them from knee-jerk reactions and panic-driven decisions when the market takes a dive and they can offer advice on preparing for major life changes, such as marriage or a new child.

Robos are also no match for the analytical capacity, the adaptability, and the multi-factor combinatory powers of the human mind. In the mind of a seasoned advisor, facts, trends, statistics and past performances all get combined with professional experience, and the conclusions are tailored to the individual client. Where a robo only sees ups and downs, a human advisor can reason, compare and evaluate what the relevant market movements mean, understand what drives them, and make an educated decision on how to structure and adapt their client’s portfolio accordingly.

Conservative and responsible financial planning includes and appropriately weighs a multitude of factors, depending on the client’s unique profile and circumstances, guided by a seasoned specialist who can “think ahead” and offer balanced and reliable advice. No robot can do thatnot anytime soon, anyway.

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