A new type of investment-service provider, commonly called robo advisors, is having a profound impact. Most Americans and many serious investors haven’t yet heard of these firms, but venture capital companies have already committed a quarter of a billion dollars to develop and grow them. How will these new companies affect you? They’re already changing the way your advisor conducts business.
Most robos provide software-driven investment processes. Users complete an online questionnaire that provides the information the firms’ proprietary programs require to select a model portfolio reflecting users’ need for performance and tolerance for risk. (The software is one way they differentiate themselves.) Robo software can typically aggregate all your holdings on one site, automatically rebalance your investments back to their original allocations, harvest tax losses and produce performance reports. The idea: It fulfills investing fundamentals that computers can execute as well as or better than humans, while providing a more detailed analysis of your portfolio than traditional paper reports.
Another point of difference for robos is how they communicate with their users (and vice versa). Traditional firms advocate face-to-face meetings. But some robo firms actually discourage client communication with humans—meaning client-service or investment professionals—except in rare cases. And in the middle are an increasing number of robo-advisor firms that advocate communication not in person, but through email, texting, Skype and the telephone. Their argument is that younger clients in particular—you’ll often hear the term “millennials”—don’t need face time, just FaceTime.
Transparency means that advisors volunteer complete, accurate information about their fees, returns and potential conflicts of interest. But few advisors practice transparency. Instead, they provide information that helps them win new clients, and withhold information that could cause them to be rejected.
In this regard, the robos have standards that will likely push traditional advisors to volunteer more information. Robo websites contain marketing messages, investor education, a liberal dose of hype and the documented information you need to make your selection decisions. And because their pitch focuses on the functionality of their software, they place less emphasis on impossible-to-guarantee returns.
Robo pricing is another differentiating characteristic. In general, robo fees can be 65 percent to 85 percent lower than the fees charged by traditional advisors, largely because you’re not paying for help from human beings. One firm, SigFig, charges $10 per month for its investment services, which include portfolio risk assessment and analysis. (If your portfolio is less than $10,000, it’s free.) Other robos charge asset-based fees of 0.15 percent to 0.35 percent.
There are additional fees, however. Robos invest your assets in exchange-traded funds and index funds. The funds charge fees, and you may also pay custodial fees and transaction charges.
Most robos state as a matter of principle that they do not believe active managers can outperform the markets over longer time periods. So they use passive indexing strategies to invest your assets. Those strategies, not coincidentally, happen to be the ones most amenable to execution by computer.
If you only need an investment service, you believe in passive management and you want to minimize your expenses, a robo may do the trick. This description may fit younger investors, technically minded investors, people with small asset amounts and investors with relatively simple financial situations.
The description does not fit older investors who have more complex needs and larger asset amounts. Such investors probably need multiple types of advice: planning, investing, insurance, tax and legal. You can get these services from a financial advisor or a team of professionals, but not from a robo advisor. Not yet, anyway.