One of my favorite sci-fi movies is Arnold Schwarzenegger’s The Terminator. It’s set in a dystopian world that’s ruled by Skynet and robots who want to kill every human.
In some ways, Skynet is already here with Alphabet (GOOG) having bought the robot firm Boston Dynamics. Not to mention we have high-frequency trading in which bots account for up to 80% of the daily volume on the stock market and buy and sell stocks in microseconds.
Computers to aid with finance are already here too.
So the question is: Can they help with your own investing?
Can computers replace humans and give sound financial advice? Previously when investing, your choices were pretty limited.
It was only until recently you had only one of two options when investing:
- Do-it-yourself (DIY)
- Hire a financial investment advisor (FIA)
Historically the problem with trying to get an FIA was many have minimum asset requirements of $500,000 or more. This requirement puts many FIAs out of reach for younger or lower-net-worth individuals.
So these individuals had to fend for themselves or take generalized advice from a financial guru like Suze Orman (don’t get me started).
In addition, it’s not uncommon for FIAs to charge 1%–2% annually (or greater via the loaded investment products they pushed you into). That’s 1%–2% you have to do better than the market just to keep up. As history has shown, this is a steep fee to overcome and in many cases also came with substandard financial advice to boot.
The issue for many individuals is they aren’t cut out to go it alone. Gone are the days when everyone who retired automatically got a gold watch and a pension (which was managed by a professional). Today you are required to self-fund your retirement.
401(k) plans and IRA accounts put individuals in the investment driver’s seat. But many individuals do not have the time to read up on investment analysis. Worst yet, they may have poor investing psychology and jump out of the market at the absolute worst times (buying high and selling low).
What Is a Robo-Advisor?
There are many definitions of what exactly “robo-advisor” means. To put it simply, a robo-advisor is a method to automate the asset allocation of investments via a computer algorithm. In a broader sense, a robo-advisor may also include human financial advisors but only for services that require human assistance (i.e., taxes, retirement or estate planning).
Overall, I consider the rise and interest in automated investment services a “good thing,” pushing down the costs of high-fee Wall Street advisors that offered no real value and, if anything, were a drag on returns. This is a great thing in any competitive marketplace. In addition, these firms are helping individuals with goal setting and asset allocation — when they typically have no clue where to begin.
As with most anything, one size does not fit all when it comes to financial advice. I do see this space filling the need of most beginner investors and investors with an uncomplicated financial portfolio.
But are robo-advisors right for you? That depends upon your net worth, the complexity of your investments and whether you feel comfortable enough to do it yourself.
I’m definitely not in the camp with those saying these robo-advisors add no value and you could easily replicate them yourself just by using Fidelity or Vanguard funds.
In my case, most of my family assets are DIY, but I’ve also been studying this for years and feel comfortable doing this — other individuals may not, and I get that. In full disclosure for purposes of reviewing and testing, I have accounts with Motif and Personal Capital.
Keep in mind what these firms are offering is not unique. A target-date mutual fund has some similarities. All of these firms base their automated investment guidance using Modern Portfolio Theory (MPT), Efficient Market Hypothesis (EMH) and a series of questions to determine your risk profile.
While this investment strategy isn’t perfect, it sure beats what most individuals have — which is nothing. It’s usually a hodgepodge of investments with no asset allocation, actively managed funds, high annual fees and whatever “investment du jour” their peers recommend investing in.
Firms like Wealthfront focus on the end goal and are ideal for individuals who don’t care or want to learn about the details of investing. For these individuals, the 25 basis points (otherwise known as a 0.25% annual fee) or less they pay is well worth the fee and in many cases much better than hiring an FIA — in terms of both cost and good financial advice.
The online tools robo-advisors offer aren’t new, though. Traditional financial advisors had the same tools available to them for years and could roll up a personalized asset allocation plan specific for you. Heck, this stuff was available in 1999 when I first used an advisor at PaineWebber. Like self-checkout at Home Depot (HD), this is pushing the technology down to the masses. You have direct access to manage your account, and it removes the no-value-added middlemen.
Let me be clear: Some financial advisors can add tremendous value. They can give guidance to the asset allocation best for you based upon unquantifiable factors, which computer programs can never do. Though I believe this is more the exception than the rule.
Financial advisors can give recommendations about long-term life decisions (e.g., helping plan for a child’s education through a recommended action plan). In fact, some of the robo-advisors mentioned in this article are just tech-assisted firms and not 100% automated. If you want it, the human element is not completely removed from the loop with some of these firms.
There’s something to be said with any 100% algorithm-driven investment approach. While it might help with a high percentage of individuals, there are always cases in which automated guidance isn’t appropriate.
List of Robo-Advisors
|Charles Schwab Intelligent Portfolios||Automated||Full Review|
|E*TRADE Adaptive Portfolio||Automated||Full Review|
|Fidelity Go||Automated||Full Review|
|LearnVest||Human Assisted||Full Review|
|MarketRiders||Human Assisted||Full Review|
|Motif Horizon Models||Automated||Full Review|
|Personal Capital||Human Assisted||Full Review|
|Rebalance IRA||Human Assisted||Full Review|
|SigFig||Human Assisted||Full Review|
|Stash Invest||Automated||Full Review|
|TD Ameritrade Essential Portfolios||Automated||Full Review|
|Vanguard Personal Advisor Services||Human Assisted||Full Review|
Aren’t All Robo-Advisors the Same?
To the casual reader, the differences between firms might seem minor but in reality are not. You have a choice between:
- Minimum Deposit — With some firms you can start out with nothing, and others require sizable amounts to start with.
- Annual Fees — Be aware of hidden costs and ETF fees.
- Asset Allocation — Asset allocation can vary quite a bit based upon your age and the way you answer their risk assessment questions.
- Account Type Support — Do they offer individual, joint, IRA, etc.? No firm can manage a 401(k) directly, but some do offer guidance in investment selection.
- Automation — Some services are 100% automated vs. human-assisted advice.
- Tax Optimization — Services like Tax-Loss Harvesting.
- Custody of Funds — Managed either by you, in which case they give trading advice, or directly by the firm.
- Management of Assets — Manage all your assets or just a portion.
- End Goal — Retirement only or other goals (e.g., college education).
Out of all the services, Personal Capital is the most expensive but also has the most human interaction with its clients. It could be said Personal Capital is much more of a traditional financial advisor that uses technology to assist. Personal Capital’s fees also include trading fees, and it mostly recommends individual stocks to minimize expenses and taxes as well. So its true cost might be more in line with the other firms mentioned.
Cost is an important consideration in picking your robo-advisor. Be aware the robo-advisor fees are only for their services — it does not include the ETF fees they purchase on your behalf. If you are curious, I’ve researched the popular robo-advisors and break down the true annual costs of each robo-advisor.
Are Robo-Advisors a Viable Business?
The biggest issue with any of the robo-advisors is whether they can survive. 0.50% or lower in annual fees might seem like a lot, but in reality it really isn’t for a firm that has a decent amount of overhead (employee, technology infrastructure and compliance). The current largest independent firm, Betterment, just eclipsed the $6.1 billion mark of Assets Under Management (AUM). While that might seem like a lot, Vanguard, in comparison, has $2.86 trillion in managed assets. In order for any of these firms to be profitable, they need multi-billions of AUM.
Many are well funded by venture capital. Betterment recently announced a series E round with a total of $205 million in startup financing. These firms are still relatively new, and it remains to be seen if they can reach critical adoption mass.
Betterment recently changed the pricing for its digital-only service and also, for an additional fee, offers guidance from human advisors.
Expect mergers and closures in the robo-advisor space within the next few years. In 2015 alone, three events occurred.
Jemstep changed its focus to target financial advisors rather than retail investors. We’ve removed mention of this service since it no longer targets the retail investor.
However, none of this should be a surprise. The same occurred with online brokerage firms. Perhaps a traditional brokerage firm like Fidelity Investments will purchase one of these companies. In reality, these firms are technology companies that are offering financial management. In my opinion, however, it’s no question robo-advisors are the future of the financial industry for the most basic advice.
Like how Vanguard revolutionized investing with indexed-based low-cost funds, robo-advisors are doing the same with asset allocation for the masses.
Are they perfect? No. It can be said if you have the skills you might be better off rolling your own, but then again that’s not the audience these companies are targeting. They are filling a niche that’s been missing for years in the investment advisory space.
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