You might not have heard of robo-advisers; they’re a relatively new addition to the financial services industry. But you’ll be hearing a lot about these online money managers in the future. And you might even want to hire one.
My firm, Paladin Registry, has already identified 23 robo-adviser services offered by the likes of Vanguard, Wealthfront, Betterment and 15 startups funded by $250 million of venture capital. Charles Schwab is reportedly planning to introduce one soon. And several major venture capital firms are betting big money that these advisers will change the way you invest — much the way Amazon changed the way you buy…well, everything.
Many experts say the Robos will primarily appeal to computer-savvy Millennials. I have a different opinion.
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Boomers and Gen-X’ers may not have grown up using computers, but they are savvy about applications that matter to them — from Yelp to online banking forms. Anyone is a candidate for using the Robo planning and investment services. All you need is access to the Internet.
What Are Robo-Advisers?
Just a few years ago, there was one type of financial adviser. He or she met with you face-to-face and could have been a financial planner, an investment adviser or a stockbroker. I’ll call this type a PFA (Personal Financial Adviser) because you received tailored investment solutions in person.
Along came robo-advisers, with three unique characteristics.
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First, all of their advice and services are delivered over the Internet, which is why some members of the media call them Online Financial Advisers. Due to their automated processes, several Robos charge fees that are 75 percent lower than their all-human counterparts.
Second, depending on their professional staff, they may provide either automated cookie-cutter or tailored investment processes.
And third, communication with clients is generally limited to email and telephone. (A few robo-advisers may be willing to meet face-to-face if you’re located in their cities.)
Paladin has researched 23 Robos and published free reports on each of them on our website, showing how they differ, what they offer, how much they charge, how they work with clients, how much money they manage and other information to help you conduct your due diligence. The reports contain information obtained by reviewing the content on the Robos’ websites; their Terms of Service documents and reports on regulatory agency websites (such as FINRA.org and SEC.gov).
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Automating Your Investing
Many of the Robos have changed the way you invest by adding several automated processes.
For example, after you complete a questionnaire, the Robos' computer programs select your model portfolio; allocate your assets between stock and bond index funds (or Exchange Traded Funds, also known as ETFs); rebalance your portfolio; harvest tax losses (selling securities at a loss to offset a capital gains tax liability) and produce quarterly statements that include performance data.
In essence, the robo-advisers have replaced expensive investment professionals with computer programs and algorithms. Their key professionals are mathematicians.
Robo-Advisers’ Model Portfolios
Many of the Robos put clients with similar financial characteristics in the same model portfolios. For example, two 60-year-old investors with identical risk tolerance and the same time horizon will be invested exactly the same.
Automation and model portfolios allow Robos to provide low-cost services because they’ve eliminated multiple layers of expensive planning and investment professionals. The tradeoff is that your portfolio won’t get the kind of personalized attention that a traditional financial adviser could provide.
Active Vs. Passive Management
There is one other key Robo characteristic you should be aware of: Robo-advisers aim to match the performance of a market index (such as the S&P 500), not beat it. Passive management keeps fees low and delivers investors guaranteed market rates of return.
In other words, robo-advisers adopt a “passive” management style, as opposed to a beat-the-market “active” management style of mutual funds run by stock- or bond-pickers. Active management tends to come with higher fees in exchange for the expectation of superior performance.
What You’ll Pay to Use Them
Robo-advisers have varying fee structures. A pure Robo with an automated investment process and limited human contact (such as Wealthfront or Betterment) might charge you 0.10 percent to 0.35 percent of your assets under management. Others, like SigFig, charge a flat $10 per month regardless of the amount you invest. Many Robos offer free services to attract customers and establish relationships with them.
By contrast, advisers who meet face-to-face often charge clients 1.00 percent of assets.
Is a Robo-Adviser Right For You?
To answer that question, you should first know about a little secret that Wall Street does not want you to know: Active money managers beat the market only about 20 percent of the time. And, the market-beaters are not the same managers every year. Often, a manager may outperform the averages one year and seriously lag them the next.
Wall Street prefers to sell active management because its investment fees are four to five times higher than passive management.
The big pension plans have figured this out. Many of the biggest plans in the U.S. use passive management for half of their assets and active management for the other half. This lowers their exposure to risk, reduces expenses and locks in a market return for 50 percent of their assets.
You should consider a similar strategy for your retirement assets. You might use the Robos’ passive management for 50 percent of your assets and the active management of a Personal Financial Adviser for the other 50 percent.
Everyone likes to minimize expenses, so on that score, robo-advisers are admirable. They’re a low cost way to invest in ways that duplicate the market averages.
But one thing you need to decide is how comfortable you are with adviser communications that are limited to email and telephone and possibly live chat and video conferencing services — but not face-to-face sessions.
Are in-person meetings worth thousands of dollars of additional expense each year to you? That's a question you'll have to answer yourself.
Going forward, technology will play a bigger and bigger part in your relationships with financial advisers. I say: You should embrace the technological advances and use them to help you improve your results and cut your costs.
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