I’ve come across several articles lately about the emergence of online sites (sometimes referred to as “Robo-Advisors”) which customize and automate the investment process for individuals. These sites are totally separate from discount online brokerage firms which allow you to buy and sell stocks at low rates. Robo-Advisors create investment portfolios, most often by utilizing securities which replicate broad market indexes. They collect fees for this service, generally is the form of annual fees taken as a percentage of invested assets (approx .15% – .50% per year).* The asset mixes are generally created after analyzing personal data including age and risk tolerance. While people in the financial services industry have fairly strong opinions about these websites – some think they will fail over time while others fear they may capture a serious portion of the traditional business – I think it’s clear that the investment advice industry has plenty of room for both traditional wealth managers and the many online solutions which are popping up. Let’s look at both sides of the debate:
For starters, there is massive opportunity within a particular investable asset space which traditional wealth managers typically don’t even approach: clients with assets under $250,000 and especially under $100,000. Many firms don’t take on clients that ‘small’ despite the fact that people in this early emerging wealth space are often looking for customized investment advice and financial planning services. The online solution may work well for this group. It may work well forever or it may work well until they have several hundred thousand dollars, a spouse, some kids, and a growing number of complex financial issues which require them to hire or at least consult with a traditional financial advisor. I don’t know the exact size of this underserved space, but there are many, many billions of dollars up for grabs there.
Further, we’ve entered an era in which tech firms are generating an increasing amount of wealth in our country. These tech oriented employees aren’t scared off by online solutions the way some members of the Boomer generation tend to be. Quite the opposite – many of them prefer automated online solutions for everything. This could mean a gradual but steady flow of assets into automated financial websites as Gen Y continues to age.
Also working in favor of Robo-Advisors is the anti-fee subculture which has emerged along with the popularity of index investing. As a result of that, some people will always flock to the lower cost solution, even before they fully determine whether or not they are losing something as a result of the cost savings. Low fees generate a lot of interest, and most of these Robo-Advisors have fees which are substantially lower than the costs of traditional wealth managers.
Now, to take the other side: technology can’t do everything – at least not yet. Offering financial advice is a very important, very sensitive, and very subjective task. While a computer may be able to determine your approximately correct asset mix by knowing your age and risk tolerance, they can’t get a feel for the ‘soft’ information, the often unspoken information which advisors try so hard to gather from clients. I’m talking about clients who say they want an all-stock portfolio but then call you up to check their portfolio values every day. These people aren’t quite sure what they want and it’s the advisors job to try to understand them and build a customized solution which meets their needs.
The next big obstacle for Robo-Advisors is stocks. From what I’ve read, most of these online firms build portfolios using investment products which offer exposure to market indexes in both the equity and fixed income space. The problem with that is the many, many investors who want exposure to specific stocks. This is particularly relevant right now at a time when market indexes may appear a bit frothy. Reducing exposure to indexes in favor of individual stocks may provide huge value creation for a client. My point is that having the ability to invest not just in securities which replicate broad market indexes but also in individual stocks and bonds is crucial to the financial plan of many investors, especially those with substantial portfolios. If Robo-Advisors are to attract higher net worth people, they will likely be those that strictly adhere to the philosophies of passive management and index investing.
Perhaps most importantly, is the quality and broadness of the advice which one receives. My experience has been that most automated financial firms are focusing strongly on creating investment solutions through generic questionnaires. However, the implementation of the investment platform is often the last step when putting a comprehensive financial plan into motion. Consideration must be given to a client’s tax status and needs, their estate planning concerns and insurance needs including life, long-term care, and disability. Any of these issues could dictate the specifics of an investment solution, therefore disqualifying the online option as a viable solution. Along these lines, coaching a client through the financial obstacles dictated by the death of a family member or a divorce requires a substantial amount of customized advice and human interaction. These would tricky issues for the online world to automate.
One final point here which I think is important: the stock market has been doing incredibly well for many years now, since the dark days of early 2009. When markets are doing well, everyone looks good. The real test for our industry comes when the markets experience prolonged periods of decline. This is when people need advice the most, especially those who are actively withdrawing from portfolios and start to worry about the long-term sustainability of an investment plan. For automated investment platforms, the next serious market decline could be key in terms of either capturing a new group of investors or alienating part of the customer base which they already have.
In any event, I applaud the folks at these firms for creating a simple and efficient investment solution for the many people who need it. I think most of them would agree that the multi-trillion dollar investment space is big enough for both traditional wealth managers and emerging solutions which service many different groups of people.
As always, feel free to call or e-mail me with any questions or comments on this article.
Russell Bailyn
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Wealth Manager
Premier Wealth Advisors, LLC
14 E 60th Street, #402
New York, NY 10022
P: 212-752-4343 *231
F: 212-752-7673
rbailyn@pfawealth.com
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