Roboadvisors were born out of the 2008 economic recession, at a time when democratizing access to intelligent wealth management was highly appealing. These automated portfolio management “advisors” provide algorithmically determined asset allocation into investment products including ETFs, stocks, bonds, and futures. The NewtonX Annual FinTech survey, which collects insights from 65 senior Finance and Fintech professionals found that the roboadvisor boom is hardly over: according to the NewtonX experts by 2021 roboadvisors will manage approximately 11% of global assets under management, accounting for trillions of dollars. But what’s really so great about these roboadvisors, and how much value are they actually bringing to end-users?
Roboadvisors Are Best at Automating Simple, Time Consuming Tasks
Roboadvisors expand wealth advice services to the common person – a move that is highly appealing to the DIY millennial generation. A senior NewtonX expert, formerly Chief Strategy Officer at a large US-based wealth management company declared: “While the typical client of a roboadvisor is worth a relatively small amount of money, when aggregated, these small-time investors represent approximately $9.8 trillion in collective assets”. Traditionally, wealth management firms only serviced high networth individuals because the amount of face-to-face time and manual labor that management required made small time investors not worth servicing. Automated portfolio management systems, though, have opened large wealth management companies up to the common man.
Roboadvisors can do three fairly basic, but time consuming tasks. By automating these tasks, firms can charge low fees — between .25 and .38 percent of your portfolio value per year, and can offer lower minimums to people just starting out. They also reduce the amount of human interaction required to define and validate these tasks, which consumers increasingly value.
As part of the 2018 NewtonX Fintech survey, we have asked our experts to rank the activities that have been most successfully overtaken by roboadvisors. They came-up with the following top 3: tax loss harvesting, portfolio rebalancing, and automated Asset Allocation
- Tax loss harvesting
Automated wealth management services can automatically sell investments when they’re down for a loss, and re-invest in similar asset profiles immediately. This provides a tax deduction at the end of the year, and leaves clients with approximately the same gain/loss in the market.
- Portfolio rebalancing
Based on instructions such as duration of investment, return goal, and values (green, social, ethical), roboadvisors can automatically ensure that your portfolio maintains its balance of assets over time, as some appreciate more than others.
- Asset Allocation based on demographics and targets
Factors such as age, income, and target cashing of investment all affect how aggressive one’s portfolio should be. Roboadvisors can automatically suggest asset allocation, and can also suggest changes over time.
Each of these tasks could be done by a human, but would be time consuming and, barring extensive experience, less precise than a robo advisor. Offering these services through automated technology in real time (without requiring confirmation from the client to execute an order) enables firms to reach a wider audience while maintaining approximately the same ROI.
It Comes as no Surprise That the Future is Hybrid
As in many areas of automation, robo-advisors are hardly doing the jobs of traditional human wealth management professionals. Rather, they’re working to enable faster, more accurate human work. High networth individuals still receive human care, and most wealth management professionals are automating aspects of the job to make themselves more efficient, and thus more competitive.
There are a few areas in which roboadvisors could use the help of a human:
1. Selling call options or buying individual stocks
Most roboadvisors are extremely adroit at rapidly choosing a variety of assets to invest in based on performance and precedent. But when it comes to giving back some of that choice to the investor, they are typically not very good at allowing for flexibility or deviance.
Risk tolerance questionnaires are great for choosing asset allocation, but they don’t get to the heart of a client’s needs and goals. That’s why many hybrid solutions will allow the machine to pick and choose the makeup of a portfolio, but for larger, more complex needs a human will step in.
Roboadvisors offer only basic wealth management services, which is why most financial management institutions are following a hybrid model for implementing them. On their own, they are a great solution for the average person on the street. With human expertise, they are a solution to offering faster and more accurate service to high networth individuals.
The hybrid model typically consists of allowing the robot to choose assets, and having the human address tax, estate, and individualized financial planning. The more sophisticated capabilities of roboadvisors, such as tax loss harvesting, also often come with higher barriers to entry, and many firms won’t offer these services until investors reach the hybrid model price point.
At higher minimum buy in price points, clients will see increased sophistication, both in their level of human care and in their level of robotic care.
Roboadvisors are Useful, but Not Human
While Roboadvisors are an extremely useful tool, both internally for financial giants, and externally for consumers, as we recently noted in an article on the impact of AI on ETFs, there are always downsides to using a rational machine on an irrational market. And if we let roboadvisors use machine learning, market regulation becomes extremely difficult to uphold because of the black box nature of the learning.
This leaves us with using algorithms based on rules and precedent to automatically create a diverse portfolio to meet client needs. For many millennials and small-time investors, that’s all they really need. While these portfolios are unlikely to appreciate by more than 2-4 percent per year, that’s still a significant boon for any small-time investor or young person dipping their toe in the world of wealth management.
The data and insights in this article are sourced from NewtonX experts. For the purposes of this blog, we keep our experts anonymous and ensure that no confidential data or information has been disclosed. Experts are a mix of industry consultants and previous employees of the company(s) referenced.