The term “Robo-Advisor” has become commonplace to describe a new breed of digital investment management solutions. Although there is not an official definition for the term, robo-advisors share a few key characteristics. Mainly, they are automated platforms that provide investment and financial planning services. Created in response to the lack of access to traditional advisors amongst less affluent investors, robo-advisors lower the cost and ease of investing in a professionally managed, globally diversified portfolio. They do this by leveraging algorithm-driven technology in the client management and investment selection process.
Here is an example of how the investment process is typically handled to help you understand what a robo-advisor is. An investor creates an account and continues through an online onboarding process, during which he or she will fill out a questionnaire about his or her financial goals and risk tolerance. The robo-advisor then analyzes the user’s answers and recommends an appropriate mix of assets for the investor. Typically the recommended portfolio is built from low-cost, passive, and broadly diversified ETFs. After the account is opened, it is typically rebalanced automatically to stay in line with the investor’s goals. Users can adjust their risk tolerance and financial goals on the platform at any time to reflect their personal circumstances; asset allocation will adjust accordingly. The robo-advisor takes over and manages the portfolio.
Robo-advisors typically charge fees as a percentage of assets managed, typically ranging from 0.25% to 0.75%. If the fee charged is 0.25%, this means that if you had $1000 invested through a robo-advisor, you would pay $2.50 per year. These details are part of what differentiates a robo-advisor from a traditional advisor, which would typically charge higher fees and require hefty account minimums. Select robos charge a flat monthly fee regardless of the amount of money you invest.
Robos were initially a self-service solution and users did not have the option to receive help from advisors. Now, most platforms either include live support or the ability to upgrade to higher service levels with access to live advisors. The professional accreditations and quality of planning that company representatives provide can vary across platforms. Some representatives are there solely for technical support to help guide prospective clients through the onboarding process. Often these representatives fall short in their ability to provide customer- or account-specific advice and meaningful planning. The highest quality platforms or service levels have licensed professionals, including Certified Financial Planners, representing more comprehensive financial planning services, and are more comparable to a full-service financial advisor relationship. These advisors are better able to discuss investors’ goals and develop appropriate strategies than a purely digital platform.
Determining what services an investor is seeking ahead of time will help them to select the right digital advice provider for their needs. A few platforms, such as WiseBanyan and Wealthfront, have stuck to the digital-only model but most providers have mixed their digital capabilities with human advisors to provide more personalized relationships with their clients.
While investment management is still the core goal and business of robo-advisors, they have expanded their product offerings. Now, they might more appropriately be described as digital advice platforms. Many have built out fairly robust financial planning tools, including net worth calculators (current and projected), financial “what-if” analyses, and retirement planners. Recently, they have ventured into traditional banking. Many providers now offer debit cards, and others are challenging large banks by offering superior interest rates on FDIC-insured savings accounts. Betterment, for example, currently offers a high-yield cash account with a 2.38% APY, as of September 1, 2019. This is more than 26x the national average of 0.09%. Thus, an individual can invest, save, and bank all from one platform at a low cost. With their expansion into banking, we expect to see more features surrounding budgeting and helping clients with day-to-day cash flows.
Started only a decade ago, digital financial advice has already grown tremendously. We estimate that digital advice providers manage roughly $440B worth of clients’ assets. The combinations of low minimums and low fees have made digital advisors an attractive option for people unable to invest through a traditional advisor or for those who want a less hands-on approach. The addition of new services all in one sleek and easy-to-navigate platform makes them even more attractive. Investing your hard-earned money—once a confusing, overwhelming, and often expensive process—can now be done in minutes at an extremely affordable cost.