Robo-advisors: A Buzzword or the Future of Investing?

Published on May 21, 2018 by Sana Ansari

Business processes are undergoing a fundamental shift, with machines taking over almost every activity. Technological advancements – be it artificial intelligence, machine learning, big data analysis, robotics, or other innovations – are making previously time-consuming, complex and cumbersome processes faster, smoother and simpler.

Tech-driven shift in investment decision making: This widespread digital revolution has enthralled many in financial services as well, including wealth management firms, leading to the emergence of fintech start-ups trying to change the way the industry operates. These start-ups focus mainly on young investors, or millennials (born approximately between 1977 and 1995), constantly looking for a crazy cheap entry to investing. One such fintech concept is “robo-advisory”, which is rapidly gaining acceptance among millennials. Start-ups like Acorns and Stash, for example, are trying to woo this massive market by accepting investments as small as USD5!

Advantages making this class of investment management popular:

• A cost-effective alternative: Due to extensive reliance on technology, most robo-advisors charge considerably less (0.25%-0.50% of assets per year) than human advisors (1%) to provide investment management and broader financial advisory services.

• Requires no or almost no minimum account balance: Many robo-advisors – such as Betterment, WiseBanyan, and WealthSimple – ask for zero to very low minimum account balances. On the other hand, robo-advisors such as WealthFront ask for just USD500 to start with, while those focusing on wealthy investors require a minimum investment of USD50,000-100,000.

• Some robo-advisors let you save while you spend: Millennials’ growing acceptance of robo-advisors has prompted start-ups to come up with very creative ideas. Apps such as Acorns, Coinflash and Stash convert investors’ spare change in linked bank accounts into investments for a small cost.

Industry bigwigs have mixed opinions: Despite its growing popularity and burgeoning customer base, this concept has mixed reviews. Asset managers like BlackRock and Point72 are investing billions of dollars in robo-advisors, and big banks like JPMorgan Chase, Morgan Stanley, Bank of America and Wells Fargo are adding these platforms to their offering portfolios; however, many investors still believe a human touch is necessary to provide a level of customer comfort.

Tech adoption for investment varies by generation: Investment habits vary by generation, with baby-boomers and Generation Xers preferring the human touch and considering the human element important for their savings, and millennials preferring computer programs. A 2017 survey by US-based AMG Funds LLC revealed that millennial investors were suspicious of human financial advice and preferred computer-generated portfolios, anticipating higher returns, as they considered them less risky. The survey also revealed that 68% of young investors used or were likely to use these tech-assisted platforms, compared to just 2% of their older counterparts.

Skepticism surrounding robo-advisors’ ability to survive a correction: Some industry experts are skeptical about a pure-play robo-advisor’s ability to survive a correction. They argue that in the event of a 20% drop in the market, robo-customers would pull out their money, irrespective of their long-term goals.

Two of the largest robo-advisors – WealthFront and Betterment – crashed in February 2018, following a market rout, leaving investors frantic with login issues. Experts believe that in such circumstances, human contact is necessary to comfort investors, as noted below:

• A Morgan Stanley note said, “The financial sector consumer often needs some sort of human contact, especially when abrupt market moves lead to unexpected losses.”

• Tobin McDaniel (Charles Schwab SVP and Head of Digital and Managed Advice) said that firms offering only automated services could be in trouble during a market correction … (as) 75% of millennials wanted to talk to a human advisor during such situations.

Focus areas for companies willing to adapt: Robo-investors should focus on the following before making an investment:

• Select correct technology: The emergence of numerous players offering similar services restricts investable opportunities for investors; however, there are start-ups that offer exclusive features, and investment in those platforms may create value for investors.

• Identify target market: Firms adding robo-advisors to their offering expand their services to a new segments – the tech-savvy, young, mostly new investors, conscious of paying a high fee. Such firms need to understand this segment’s profile when planning offerings and communications.

• Develop confidence in robo-brands: The association of big names with robo-advisors is boosting customer confidence in this newly evolved investment class. Hence, investment firms should also assess their branding efforts, especially as they target new users.

Acuity Knowledge Partners extensively supports hedge funds, banks, and other financial firms with their research and analysis. We specialize in providing periodic updates, sector analysis, opportunity evaluation, and related services on a global scale.

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