Take emotion out of investing.
That basic maxim of financial success—that the euphoria of an up market, the anxiety of tumbling stock prices can cloud your thinking when it comes to acting sensibly around your money—is one of the most difficult to live by. In fact, evidence suggests that most individual investors are emotional and shift their strategies at the wrong times, reducing their potential returns. But humanity doesn’t have to get in the way of your portfolio management.
Why not try a robot?
Well, maybe not a cyborg but an automated advisor that uses algorithm-based software to provide portfolio and investing advice. Known as robo-advisors, these digital disruptors—emerging firms such as Betterment, Wealthfront and Personal Capital—are not just focused on developing simpler and less-expensive methods of delivering financial advice. They’re upending one of the main tenets of investing: the need for face-to-face interaction and a human touch for financial advice.
The truth is, consumers no longer believe in the necessity of that human interaction. Nor do they necessarily believe in the advice they’re getting from professionals. A study by TIAA found that many Americans (47 percent) have never worked with a professional financial advisor. The reasons? They think it will cost them more than they can afford, they don’t trust the advice they’re being given, or they don’t know what questions to ask.
Making better trades
The robo-advisor insurgents aim to take on that challenge, meeting the opportunity to make wealth advice and services feasible to a greater number of people. They make it easy to open an account, they limit fees through the use of low-load investments and exchange-traded funds, and instead of time-intensive face-to-face consultations, they have user-friendly digital platforms that use simple questionnaires to identify investing goals and algorithms to determine things like risk profiling and optimal asset allocation.
Robo features such as portfolio rebalancing and tax-loss harvesting can translate into higher returns for investors. Betterment, for instance, estimates that tax-loss harvesting—where investments are sold to generate a loss to offset capital gains—can add 0.77 percent to an average customer’s after-tax returns annually.
And investors are taking notice. In the U.S., robo-advisor assets under management have grown threefold from around $60 billion in 2015 to $182 billion this year, according to Statista. And by 2021, that figure could top $500 billion. While significant, it still represents only a fraction of retail investable assets.
A focus on customer experience
Many of today’s investors are better informed and want greater control over their financial future. Perhaps that’s why the financial services industry is going through a customer experience-driven transformation. In the latest version of its annual Digital Trends in Financial Services and Insurance report done in partnership with Econsultancy, Adobe found that customer experience was the top priority of 63 percent of FS executives, a 17 percent increase of 2016. Still, many acknowledged that their industry’s capabilities were lagging behind in terms of using data. But AI and robo-advisors were identified as one of the top growth opportunities for the coming years.
At the same time, demographic shifts are affecting key segments of the investor population. Traditional wealth managers have had trouble connecting with Millennial and Gen Y investors, who are both tech-savvy and more willing to take a do-it-yourself approach. And since many advisors are older, there may also be a generation gap. According to data from Ernst & Young, just 18 percent of financial advisors in the U.S. target Millennial clients.
Youth is served
Younger investors have been the driving force behind the growth of robo-investing. For example, more than half of Wealthfront’s clients are under 35 and nearly 90 percent are under 50.
Its newest financial-planning feature called Path lets customers explore various financial scenarios that may come up in their future—such as saving for retirement. By linking their checking and investment accounts to Wealthfront, users can play around with things like their level of savings and see how changing habits can impact their future. Planning for college, buying a house or saving for retirement are things human advisors used to do, but Wealthfront remains entirely dedicated cutting out humans (short of helping them design their algorithms).
A hybrid approach
Others see robo-advisors as a tool that can enhance the existing advisor-client experience. Betterment, which began as a fully automated robo-advisor, recently rolled out a human-robot hybrid (for a higher fee) alongside its all-algorithm tier. Personal Capital combines digital client portfolios and investment automation with periodic phone reviews with a human advisor.
And the robo-advisor startups are no longer alone. Almost all the major investment companies—including Vanguard, Schwab, Fidelity and Wells Fargo—have come out with their own robo-advising services, typically coupled with the option for human advice. The goal: provide a superior experience where the robo-advisor can serve as a digital front-end, but humans can be available to provide guidance, especially in stickier situations like retirement planning for older investors.
Robo-advisors are still in their infancy and have yet to be tested by a bear market. Could emotion take over? That’s what robo-advisors will be taking on in the future. As Andrew Lo, director of the MIT Laboratory for Financial Engineering, recently wrote: “What if a robo-advisor could identify the precise moment you freak out and encourage you not to sell by giving you historical context that calms your nerves? Better yet, what if this digital advisor could actively manage the risk of your portfolio so you don’t freak out at all?” When emotions run high, that’s the time for a data-driven investment experience.
