Robo-advisory is the new buzzword that has been growing steadily within the investment industry for the past five years. Put simply, it refers online wealth management services that give portfolio advice based on statistical (and back-tested) methodologies and execute orders algorithmically and cost-efficiently.
Despite its relative youth, robo-advisory services have already disrupted the investment industry and have started to eat into traditional financial advisory models. A study by AT Kearny in 2015 found that billions of dollars in funds have been channelled to automated investing services such as Betterment or Wealthfront – this trend is only set to grow. The report goes on to say that as much as six per cent of all U.S. investments – about $2 trillion worth – will be managed by robo-advisors by 2020.
Leading robo-advisory firm Wealthfront states that 90% of its 30,000 clients are under the age of 50, while 60% are under 35. This means that they have targeted the next generation of investors who are not cash rich, and for whom the fees charged by financial advisors can be a stumbling block.
The key value proposition rests on the notion that an algorithm executing orders for an amalgamation of investors would not just be cost-efficient, but time-efficient as well. The investor, other than doing the initial account set-up, need do virtually nothing as his or her money gets put to work in a rational and logical and methodological manner by sleepless algorithms.
Wealthfront’s minimum investment sum is only $5,000 and the service is free if you have less than US$10,000 in assets. Its chief rival in the space is Betterment – without any minimum investment fee.
However, what these automated advisors don’t provide you with are the soft services that the financial and private banking industry thrive on. This comes in the form of face-to-face contact, personalised advice and investment strategies as well as (depending on your relationship and wealth) the ability to plan and advise on other things like payment of school fees or insurance.
The billion dollar question remains. Which service performs better?
The real answer is that it’s too early to tell. Since robo-advisors only came onto the scene in the last five years, there really isn’t enough data to declare a winner.
One of the most comprehensive studies to date has come from Cullen Roche, founder of the Orcam Financial Group, which did a comparative study of the performances of the leading robo-investing platforms with leading funds in 2014.
The study found that on the whole, robo-advisor companies did not outperform funds, but rather mirrored them in their performance.
For example, Betterment’s aggressive portfolio made a 12 month return of 3.43%, which was largely in-line with Total World Index from well-known advisory firm Vanguard. Based on this report, the author added: “For the most part, the robo advisors look like another Wall Street sales pitch trying to charge a fee for something that you really don’t need to be paying for.”
The crux of the matter therefore is, what the type of investor you are. There is no doubt that the growth of robo-advisors is disrupting the industry. There could be a way in which the two methods could co-exist as they seem to be targeting different industries.
The early stages of algorithm based portfolio management seem to point towards a younger, less investment-active type of investor – a group of people (aged under 35 who might only be investing $5,000) who were not previously on the radar of human investment advisors.
This demographic is a digital native, fee sensitive and comfortable with the notion that an automated system is as good as a highly paid human advisor when it comes to portfolio allocation. The traditional advisor is still focused on the higher end of the market, where people appreciate the face-to-face nature of business and the advisor’s attention to other intangible needs.
Only time will tell if traditional and new-age methods of financial advisory can co-exist, or if digitization and automation continue on their trajectory and dominate the market.