Robo-Advisors: Automated Investment Advisors

Abstract

Robo-advisors can be classified as advanced digital platforms that provide best in class computerized, algorithm-driven financial planning services, with lower fees and nil human interference. Robo-advisor uses online survey to gather client’s information regarding his/her financial situations and future goals through and then utilizes this data to offer advice and automatically invest client assets. Best robo-advisors offer superb features like easy account setup, strong goal planning, portfolio management, account services, superb security, conscientious customer service and low fees.

Understanding Robo-Advisors

The first robo-advisor, Betterment was launched in year 2008 and it started accepting investor money in 2010, during the Great Recession. Its preliminary purpose was to rebalance assets earmarked as target-date funds and manage passive, buy-and-hold investments through a simple online interface.

Wealth managers have been using automated portfolio allocation software from year 2000 and up to 2008; they only who used the technology. Clients had to use the services of such financial advisors to benefit from the innovation. But thing s became easy with the advent of robo-advisors which used passive indexing strategies and optimization using modern portfolio theory (MPT). Robo-advisors today offer varied portfolios for socially responsible investing (SRI), Halal investing, or tactical strategies that almost imitate like hedge funds.

The influx of modern robo-advisors has brought delivery of services straight to the consumers. And with further advancements, robo-advisors are now able to handle much more complicated tasks, such as tax-loss harvesting, investment selection, and retirement planning. The industry has experienced unpredictable growth with robo-advisors managing $987 billion business in 2020 and further expectation of reaching $2.9 trillion worldwide by 2025.

How Robo-Advisors earn

Most robo-advisors earn money via wrap fee based on assets under management (AUM). While traditional (human) financial advisors typically charge 1% or more of AUM in a year, most robo-advisors charge around 0.25% per year. Robo-advisors charge such lower fees because they use algorithms to automate trades which utilize commission-free and low-cost ETFs.  Robo-advisors can earn in several other ways. One of such way is the interest earned on cash balances, which gets credited to the robo-advisor.

Another income way is payment for order flow. Typically, robo-advisors will build up funds by adding them from deposits, interest, and dividends, and then execute large block orders at just one or two points in a day.  This allows them to execute lesser trades and get favourable terms due to the large order sizes. Many at times these large orders are placed with particular liquidity providers who in return give rebates that are paid to the robo-advisor.

Robo-advisors can also make money by marketing financial products and services for example loans, credit cards, insurance policies etc. These are often done through tactical partnerships.

What are the good features of Robo-Advisors?

1.      Human Financial advisor services with a mix of Robo-Advisor Services – Traditional financial planning practices are white labelling robo-advisors’ platforms for their clients. Traditional financial planners become free from the burdensome task of choosing assets, so that the financial advisor may spend more time with their clients doing other works like individual tax, estate, and financial planning.

2.      Intensifying the Market for Financial Advice – Clients with lower net worth usually do not use professional financial advice. But more consumers choose services of robo-advisors due to ease of access and lower fee models.

3.      Lower Fees Charged – The Robo-advisors charge a cost of zero to 0.25% as their service fee which is well lower than what Human Wealth Managers were charging.

4.      Wide range of Robo-Advisors – There are different low-fee robo-advisors for different types of clients. There are robo advisors for someone interested in a certain sector or investment theme, someone who is concerned about rock-bottom fees and there are several robo-advisors which brandish diversified low-fee ETF portfolios while others claim rebalancing and tax-loss harvesting in their arsenal.

5.      Suggested by Nobel Prize Winning Advisors – Betterment and many of the robo-advisors build their investment models were suggested by Nobel Prize-winning investment theories. With the teachings and guidance of Harry Markowitz (1990 Nobel Prize winner) and Fama and Shiller (2013 Nobel Prize winner), the Robos used cutting-edge investment portfolio research to drive their products.

What are the factors missing in Robo-Advisors?

1.      Yet to get 100% Personalized – Clients are not just investment portfolios. They have goals, both for the near and long-term. Robo-advisors usually set and edit their client goals using financial planning software; but clients do have other issues like money-related etc. which gets solved from a chat with a human being. The human financial advisors are there to relax your fears and explain how the investment markets work, when the market falls. Further, a financial planner works to integrate your finances, taxes, and estate plans. Even sophisticated and young investors may plan for investment portfolios which includes wider range of asset classes than the typical robo-advisor offers.

2.      No Personal Meetings – If Client needs relationship with financial advisor, then most robo-advisors aren’t at all suitable. Robos don’t have offices where a client can walk in and talk directly to an advisor. This type of personal contact management is relegated to the traditional financial advisory models.

3.      Advisors’ Price Schedules – It’s correct to say that most robo-advisors have low price schedules, but not all and similarly it is not true that all financial advisors are expensive. Some financial advisors charge approximately similar to what a robo-advisor charges. Some financial advisors charge an hourly rate, or a fee for service. This practice allows Clients to control costs while receiving more personalized information. Even some of the web-based financial advisors can give up the cost of a extravagant office and serve Clients personally via web chat for lower fees.

4.      Not the only resource for Newbies – With the multitude of financial advisors, there are various pay models and investment approaches to fit every investor and same stays true even for younger generation or new investors with lesser income.

Standalone Robo-Advisors

Some of the earliest pioneers of digital advisory technology have advantage of most competitive fees with low to zero account minimums. Clients can start from scratch with these platforms.

Robo-Advisor	AUM	Features	Annual Fee
Betterment	$21 billion	Overall planning; IRAs/401(k)s; access to advisor	0.25% – 0.4%
Wealthfront	$21 billion	Overall planning; tax optimization	0.25%
Personal Capital	$17 billion	Every client is matched with an advisor; tiered services; tax optimization	0.49-0.89%
Blooom	$5 billion	401(k)s/403(b)s; access to advisor	$45, $120, or $250
Ally Invest	$276 million	Goals-based planning tools, low-cost, non-proprietary ETFs	Free

 

 

 

The way forward

Since launching more than a decade ago, robo-advisors have grown into an industry that handled $460 billion in 2020 which made is almost 30% increase from 2019. Further predictions are made that the industry will touch $1.2 trillion business by 2024.

Investors in the past had two options when it came to managing their investments. They do it themselves or use the services of a financial advisor but with the advent of robo-advisors, a third option added up. And this sudden rise to eminence was made possible due to massive interest and support from millennial and Gen Z.

Luck is favouring robo-advisory industry as the technology continues to improve and the younger generations accrue more wealth. And these young generation Clients look forward for easier setups like Robo-advisors to suggest them on the investment decisions. Robo-advisors will go a long way.