Like most things, it is human nature to jump on the latest new fad — especially if marketed as something “cheaper and better.”
The popularity of Robo-Advisers is just that. It is the industry’s response to the price compression experienced by most investment advisory firms.
However, the ability to be profitable against the competition of well-established giants like Schwab and Vanguard requires large scale and branding. The growth of most new Robos can be attributed to large infusions of venture capital backing.
The typical “Robo-Adviser” charges an annual fee between 0.15% to 0.35% depending upon the size of the account. Some advisers who charge 0.50% annually are also in the Robo category, but provide “future rebalancing and dividend reinvestment” or other services. Others may go further and add more services such as tax loss harvesting charging up to 0.89% annually.
It is estimated that the Robo-Advised platform will reach $50 billion by the end of the year. This is somewhat akin to the emergence and popularity of HMO (Health Maintenance Organization) whereby the smaller players eventually went under or were purchased by the large health insurance firms.
On February 17, 1971, John Ehrlichman, counsel to Nixon, described an HMO: "All the incentives are toward less medical care, because the less care they give them, the more money they make."
The profitability depended upon “less services rendered by doctors and/or other professionals who have agreed by contract to treat patients in accordance with the HMO's guidelines and restrictions in exchange for a steady stream of customers,” thus, ultimately needing volume for the system to be financially beneficial for all involved.
The analogy is similar in that for Robos to succeed, based upon the low fee structure, there has to be smaller overhead — translating into a technology platform built to eliminate the need for a face-to-face adviser or the additional costs associated with it.
The question though, is this appropriate for all investors? It depends upon who the client is, where they are in their life cycle, how much money they have, and how much face-to-face advice they need based upon their goals.
Most Robos use exchange-traded funds (ETFs) or some form of inexpensive institutional indexing to enable the access to the Robo platform at a low cost.
Perhaps another reason Robos may have become more popular is the six year bull market has been the third largest in U.S. history. Diversification within active management just didn’t work that well in the last six years. The S&P 500, a measure of the broad equity market, is up over 25% annualized since March 9, 2009 (the bottom of the bear market or beginning of bull).
Many investors cannot rationalize spending more for active management in a diversified portfolio that performed worse than the market, regardless of risk statistics. This is pretty typical in behavioral finance. The pendulum often swings in favor of indexing at the heels of most long bull markets.
On the other hand, in hindsight, no one was happy to own the S&P 500 index in 2008. But those who had active balanced managers that mitigated the downside risk, and were down less than half that of the market decline, were heroes and those managers experienced large inflows.
Like many things, in Financial Planning, there is no “one size fits all”. Many predicted Amazon would put all department stores out of business, but that hasn’t happened yet. The reality is, people want someone they can speak with who can provide comprehensive financial life management.
A live expert to help them with their financial dilemmas: how they should finance a purchase, help their kids pay for college, or be there for them in a crisis situation, when their loved one dies to offer the comfort they need in knowing their adviser can handle the financial matters while allowing them the time they need to grieve.
A Robo is a good solution for many, just not all. There is a reason some people pay more to stay at a Four Seasons Hotel than a Best Western. It would seem with some things in life, you get what you pay for.
Kathleen A. Grace, CFP®, CIMA® is a Managing Director at United Capital and Amazon Best-Selling Author of Prince Not So Charming, a financial planning novel.
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