Given the explosive growth of automation in so many areas of the economy, it’s no great surprise that the trend is hitting the investment sector too — for retail investors anyway. Robo advisers — automated services that manage personal investing — have taken root.
According to data from financial research firm Corporate Insight, the top 11 robo advisers’ assets under management grew by roughly 65 percent between April and December of last year, to $19 billion. A.T. Kearney, a consulting firm based in Chicago, projects that number will eclipse $2 trillion by 2020. How much staying power does the robo-advising segment really have, though?
To be sure, robo-investing has at least entered the realm of 401(k)s, making inroads into company-sponsored plans into which employees are either automatically enrolled or register for as a workplace amenity. Companies such as Financial Engines and Morningstar have automated services that they sell to plan managers and services such as Blooom, which provide the convenience of an app with the personal touch of an investment adviser. For the long haul, though, the viability of robo advisers remains untested. For one thing, there hasn’t been a lasting major stock market correction since the uptake of such applications became widespread.
“A market downturn will challenge the solvency of at least some firms,” says Sean McDermott, an analyst of robo advisers at Corporate Insight. “It comes down to how well their algorithms have formed investment allocations and how well they communicate with investors to keep them calm.”
Traditional financial advisers point out that it is in times of stress that they can be most valuable to their clients by giving tailored advice and working to prevent investors from acting irrationally.
Even without a major market downturn, the robo adviser industry could benefit from some consolidation, McDermott says. There are at least 50 fully automated investment services and more than 100 that also offer some human contact. Of the fully automated ones, only “probably 15 to 20 are worth paying attention to,” he says. “Some firms are going to be acquired, and some will go bankrupt. There isn’t enough demand to sustain all of them.” According to McDermott, the entrance of major brokers such as Charles Schwab & Co. and the Vanguard Group into the automated investing industry segment will only hasten the consolidation process.
Robo advisers typically offer a portfolio of exchange-traded funds that they purchase and manage for investors. The fees generally come to 0.35 to 0.50 percent, including ETF fees. That’s far below the 1 percent or more investors usually have to pay human advisers — before ETF and mutual fund fees. The low costs certainly help sell these services. Grant Easterbrook, a former analyst of robo advisers who recently founded Dream Forward Financial, a 401(k) service company in New York, says the attractiveness of robo adviser services also stems from greater transparency and better web sites. “People like simplicity,” he explains, “and there’s a demographic shift,” with more young investors coming into the pipeline.
One way to sustain the viability of robo advisers is to recruit a younger clientele, which is likely to be attracted to the very low investment minimums — it’s $500 at industry leader Wealthfront, for instance. “Full-service brokerage firms often aren’t interested in you unless you have at least $250,000 of assets,” says Corporate Insight’s McDermott, adding that a majority of investors using robo advisers probably don’t meet that threshold. He believes most users are probably older Millennials and younger Gen Xers, many of whom likely feel some trepidation about the financial services industry — and putting their money in it — in the wake of the 2008–’09 financial crisis and stock market crash. “Technology can offer them portfolios,” McDermott says, and help them feel at ease and in control.
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