Josh Parham, a 31-year-old living in Statesboro, Ga., decided last spring he wanted to get serious about saving for retirement. His employer doesn’t offer a 401(k), so Parham considered working with a traditional adviser. But with his initial investment of just $5,000, he wasn’t sure he could find one with reasonable fees. He also didn’t feel comfortable handling the account on its own.
Parham decided to invest his money with a “robo-adviser,” an online financial services firm that uses computer algorithms to steer users’ accounts. To get started, Parham had to answer eight questions about his risk tolerance and investment horizon and then choose from the recommended model portfolios. The provider, TradeKing Advisors, automatically rebalances Parham’s chosen portfolio as needed to make sure it matches up with his target mix of stocks and bonds.
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Parham says he was nervous about his choice at first. “The initial thought of leaving a computer in complete control of my finances was definitely on the frightening side,” he says.
Still, the ease of setting up the account and the low fees have won him over. “I don’t have the time, mainly because of work hours, to devote my time to managing my account,” Parham says. “I have been very satisfied with it.”
Computerized services like the one Parham uses still make up a tiny fraction of the wealth management industry, but they’re growing fast. Last year, robo-advisers were managing about $19 billion in assets, an increase of 65 percent in just over a year, while traditional retail advisors saw an increase in assets of 7 percent, according to Corporate Insight.
The startups at the forefront of the movement are growing at a similarly fast pace. Wealthfront, for example, launched in early 2012 and reached $1 billion in assets under management in less than two and a half years. It reached $2 billion nine months after that.
That success has drawn the attention of the industry’s heavyweights. Fidelity has partnered with Betterment, a leading robo-advisory company. And this week BlackRock, the largest asset-management company in the world, announced that it is buying a robo-adviser called FutureAdvisor. BlackRock said the deal would enable the financial institutions it works with to better meet consumers’ investing and retirement-planning needs. “This need is particularly acute among the mass-affluent — a large segment accounting for 30 percent of total U.S. investable assets,” the BlackRock announcement said.
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If financial giants see an opportunity, it’s because individual investors are increasingly comfortable with the software-driven approach to managing their money. Robo-advisers appeal to investors who want professional advice about handling their money and to millennials who are used to performing most tasks — from booking travel to buying groceries — online and on their own.
“This is for that tech-dependent generation where they are not relationship-oriented,” says Wilson Moy, director of financial planning at the American Armed Forces Mutual Aid Association. “They don’t want to sit down in front of an adviser and build a relationship at this point.”
Analysts expect more assets to pour into robo-advisers as individual investors look for money management help at a lower cost than they can get from traditional advisers.
“They’ve gone through the Great Recession and the financial crisis,” says Sophie Scmhitt, a senior manager with Aite Group’s wealth management team. “Picking stocks is not exciting anymore. They’re looking for ways to preserve their investment, they’re hoping to get a return, but they’re not looking at investing to get rich.”
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While the fees and business models of robo-advising startups like Wealthfront and Betterment vary slightly, the concept is the same. Investors enter some basic information about themselves, including their age, income and risk tolerance, and receive customized advice and a portfolio — typically built using low-cost exchange-traded funds — that, at least in theory, is tailored to their preferences and goals.
That portfolio then automatically rebalances and optimizes for taxes, helping investors make sure that their custom-tailored portfolio doesn’t morph into something much different and less suitable over time.
Most robo-advisers have extremely low minimum balance requirements, making them a viable option for investors who don’t have the tens of thousands of dollars required for service at many of the larger brokerage firms.
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Wealthfront’s minimum investment is just $500, and it will manage your first $10,000 for free. Betterment has no minimum, but charges $3 per month for accounts worth less than $10,000 without automatic deposits set up to move money from a bank account to Betterment. Traditional advisers typically charge 1 percent of assets under management.
The drawbacks
Industry experts say that robo advisers are a great option for novice investors or those with simple financial planning goals. However, most services offer little in the way of holistic planning, beyond asset allocation and saving for singular goals.
If you’re trying to determine the best way to save for a new home, for example, while also paying off student loans and keeping up your retirement savings, you’ll still likely need to sit down with a financial planner who can give you advice specific to your situation.
“Broad-based financial planning involves investing, and some of the robos are doing that really effectively,” says Charlie Bolognino, founder and financial consultant at Side-by-Side Financial Planning in Plymouth, Mass. “But you can’t forget about risk management and goal setting.”
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Robo-advisers also haven’t proven themselves in a bear market yet. Nervous investors may find it easier to react to market volatility and change their allocations with a few clicks — potentially damaging their long-term financial goals because they can’t call a person who could soothe their nerves and talk them through the benefits of staying the course.
“I wonder how well robo-advisers are going to be able to prevent people from hurting themselves in those types of scenarios,” says Steve Elwell, a certified financial planner and vice president at Schroeder, Braxton & Vogt in Amherst, N.Y.
While there will likely always be demand for traditional advisers, the growing competition from robo-advisers will likely put downward pressure on their fees, much like the advent of index funds pushed traditional mutual funds to focus more on costs. That’s good news for consumers, whether they decide to invest with robo-advisers or not.
