Those of you who have been reading the investment news lately can’t help but have come across this new breed of advisors that lack souls. No, seriously, they are are quite robotic. The aforementioned are more formerly called “Robo-Advisors”. These algorithmic money managers take in your assets, ask some questions about your goals and time horizon, put your cash into a portfolio matching your risk profiles, and automatically re-balance your portfolio. If you are thinking that this is a silly concept, venture capital think differently. In the third quarter of this year, these firms raised over 100 million dollars. The recent success of robo-advisors may have had something to do with the fact that the market has been roaring forward now for several years, and a great market has never failed to convince investors that they can do it themselves. And the price might be right for many of investors looking for a lighter fee than active management. For instance, the average annual fees for actively managed mutual funds are about 1.5%. Wealthfront, a robo-advisor manages clients’ investments for 0.25%. If you want a little more human interaction, AssetBuilder, another robo firm, charges closer to 0.5%.
Investors have been driven to this medium for several reasons. The business world has seen the automated disruption in several industries over the recent years. The travel industry industry will never be the same since Expedia, Priceline, and Travelocity hit the scene. In the real estate industry, Trulia, Redfin, Zillow and Trulia have suddenly become a driving force in educating home buyers and sellers. LegalZoom has taken the world by storm to take the place of a lawyer when setting up a business. But have these online alternatives really taken business away from traditional professionals? It seems that those that use a online-in-person mix are coming out on top. Consumers are becoming way more receptive to communications that use social media, email, instant messaging and texting. A recent North American Technographics study found that, in 2010, 22% of investors agreed that online advice is just as good as advice received from a traditional financial advisor. In 2014, that amount increased to 44%.
Robo-advisors aren’t without their limitations though. They don’t offer all possible investment choices most of the time. Their automated systems can possibly omit certain factors such as particulars about a client’s personality or special needs. They don’t provide estate planning and insurance planning, which is vital to a complete financial plan. From my personal experience, it takes several conversations to really get a handle on risk tolerance, and a client’s future reaction to a severe market drop, for example. I believe that advisors will need to adapt to the times, and offer virtual access to their human advice. There is real value to hearing a client’s voice, seeing their face, and get a handle on their true risk tolerance. The same study done by North American Technographics found that 56% of investors want to research investments on their own and incorporate their work with advice from a professional. By comparison, just 24% want to do all of their investing on their own. Someone on the phone helping you get through a life change or market disruption might just be worth the extra 0.30 to 0.50% in fees.
Brian T. Eddy, MBA, CFA, CFP(R)