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The Robo Advisor: Financial Advisor Friend or Foe?

A technological innovation that is currently upsetting the status quo in wealth management is the robo advisor.

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The Robo Advisor: Financial Advisor Friend or Foe?   

In 1980, Bill Gates predicted there would eventually be “a computer on every desk and in every home,” while many skeptics greeted his look into the future with doubt and derision.  In the year following this prophetic remark, the first children of the millennial generation would be born.  Today, just 36 years later, not only is there nearly a computer on every desk and in every home, there is seemingly a “computer” in every pocket and every purse.  There’s no question that society’s reliance on technology is here to stay.

A technological innovation that is currently upsetting the status quo in wealth management is the robo advisor. So far, robos have garnered about $50 billion in assets. That figure is expected to grow fairly quickly to an estimated $285 billion by 2017, but would still account for a small slice of the asset management industry. Even so, McKinsey & Co. has forecast that robo advisors could eventually expand to $13.5 trillion worth of assets, assuming that 25% of affluent households ($100,000 to $1 million in financial assets) and 10% of high-net-worth individuals (more than $1 million in assets) choose automated investment advice.

The first robo advisors were designed to attract investment dollars directly from the public, which was understandably perceived as a threat to financial advisors. But today, a growing number of B2B robo platforms are customized specifically for advisors who want to scale their practices and provide the option of a more streamlined — and less expensive — level of service to their clients.

What Robos Have to Offer
Robo advisors are programmed to place trades, rebalance portfolios, generate reports, and perform other asset management tasks automatically using advanced algorithms, without the regular participation of a human financial advisor. The investor fills out a basic online questionnaire designed to ascertain his or her risk tolerance and investment goals.  The software builds portfolios with a mix of assets that should be appropriate for the client’s stated short- and long-term financial goals, such as saving for a home purchase, a child’s college expenses, or retirement.

The recommended allocations, available strategies, and various other features may differ significantly from one platform to another. Some hybrid services allow clients to consult with a human advisor on occasion.

Not surprising, robo advisors can manage investment assets for much less than the fee structure charged by most human advisors, which is typically 1.0% or more of assets under management (AUM). Robo fees generally range from 0.15% to 0.5% of AUM, and investors can get started with as little as $500. To achieve low costs, robo portfolios typically comprise ETFs that track market indexes.

Beyond the potential cost savings, some advantages for investors include tax efficiency and objective advice — free of the potential biases and conflicts of interests that can influence human decisions. And yet, there may be risks associated with passively managed investments (including ETFs) that are not fully understood. Another concern is that today’s robo advisors have never been tested in times of economic stress and significant market fluctuations, when frightened and/or inexperienced investors might abandon their investment strategies without a human voice to guide them.

The Future of Financial Advice
In fact, many financial services firms and broker-dealers have purchased or partnered with various robo platforms in the past year, believing that those who join forces will be in a better position to profit from some inevitable demographic and regulatory changes.

First, a projected $30 trillion transfer of wealth from traditional baby boomer investors to tech-savvy younger family members, including millennials, has already started. Plenty of market research and plain common sense suggest that employing cutting-edge technology is critical for developing and fostering relationships with millennial consumers who are used to managing every aspect of their lives on electronic devices.

The U.S. Department of Labor’s new fiduciary rule may also provide growth opportunities for low-cost automated investment platforms. The higher standard required for retirement account advice could make it more difficult for some advisors to continue working on a commission basis. A shift to fee-based accounts may drive up the cost of traditional financial advice to a point where it is out of reach for some investors with small IRA or qualified plan balances. Some firms may decide not to service small accounts based on these higher costs and liabilities.

Adopting an automated platform that fits the firm’s business model and investment style could allow an advisor to manage smaller accounts at a lower cost, and then transition these clients into a comprehensive practice (providing tailored, face-to-face advice) as they accumulate wealth and their needs become more complex.

Many clients appreciate a personal relationship with an advisor who understands their concerns and keeps them better informed, and these investors are more likely to believe that professional advice is worth the fee. If used strategically, a digital investment platform could help advisors increase their assets under management, partly by freeing up more time to build trusted relationships and focus on client needs.