As the world moves inexorably forward into the digital age, technology increasingly takes on a role in both augmenting and competing against traditional businesses. The world of financial services is no exception; in recent years, technology has taken leaps and bounds to augment and enhance what financial planners do, but now a new breed of technology firms threatens to challenge advisors as well. The rise of the so-called "robo advisor" - online startup firms that aiming to replace traditional advisors, as TurboTax did to tax preparers - has begun.
But so far, it's unclear whether the current breed of robo advisors will really make a dent in what real advisors do; in fact, the scope of most robo advisors is so narrowly focused on delivering passive, strategic, low-cost index portfolios, that arguably their greatest competition is not from comprehensive financial planners but instead from do-it-yourselfer alternatives like Vanguard and Charles Schwab!
The real test for the robo advisors, though, is the one they have not yet faced - will clients really be willing to stay the course through turbulent markets and change their behavior for the better because a computer told them to do so?
The inspiration for today's blog post is the rising number of so-called "robo advisors" - online startup firms that are claiming they will replace today's advisors with technology. Citing the conflicted flaws of the financial services industry and pointing to what TurboTax did to the tax preparer industry, they variously declare to the public that "Financial Advisors Are Bad For Your Wealth" and state that "No, You Don't Actually Need To Hire A Financial Advisor" and promise instead a low-cost, algorithm-derived, passive strategic asset allocation on their technology platform.
But are the "robo advisors" like Betterment, Jemstep, WealthFront, and FutureAdvisor really a threat to the financial services industry and the existing world of financial advisors? The answer is no, and yes, in large part because of a gross misunderstanding of the companies about who their real competition is in the first place.
Why Robo Advisors Are No Threat To Real Advisors
The simple reason why robo advisors are no threat to real advisors is that the services they offer are nothing like the comprehensive financial planning process offered by a true financial planner. For better and for worse, the low cost offering of at least the current suite of robo advisors generally begins and ends with setting an asset allocation. In other words, they're not actually financial advisors at all. They're investment advisers; in fact, most of them are actually RIAs simply operating a basic assets-under-management asset gathering business model (yet, ironically, despite being an RIA, Betterment suggest that (Registered) Investment Advisors charge "An arm and a leg" and only allow clients access to their own money "with a fight").
Because of their simplified business model, none of the robo advisors are currently prepared to offer personalized, individual advice on retirement, college education, estate, tax, or insurance issues, nor even to help with the basic budgeting and cash flow planning. They provide a diversified, passive, strategic portfolio and rebalance it. Period.
Thus, due to their fairly narrow scope and focus on simply implementing an investment portfolio, the truth is that most of the robo advisor platforms would be more likely to be referred by a financial planner than competition with one, especially for the subset of financial planners who do not operate on an assets under management business model and must refer clients out for implementation. Or at least, the robo advisors might have received referrals from financial planners before publicly trashing them. Instead, most financial planners who prefer to refer clients out to low-cost, passive investment managers will likely continue to rely on the services of firms like Vanguard and Charles Schwab, who understand that it can be beneficial to their mission and the public to work constructively with real advisors.
How Robo Advisors Will Be A Threat To Some "Advisors"
Notwithstanding the preceding statements about how the robo advisors are no threat to real advisors, these startup firms may well be a threat to another group - those who call themselves "advisors" but fail to deliver any real advisory value.
The first group likely to be challenged by the robo advisors are the subset of those who call themselves financial advisors but are actually nothing more than high cost product distributors who will be challenged by the dramatically lower costs of the robo advisors and the simplicity and ease of their implementation. Such individuals, who may use the label "financial advisor" but don't necessarily offer any more actual financial advice than the robo advisors, have been shown to do little to help clients achieve better outcomes, and may be challenged if they have to compete with the robo advisor model. Although in point of fact, the sales-based financial advisor distribution model is already under attack and losing market share rapidly to fiduciary, advice-centric financial planners, so in reality the robo advisors are more likely to simply participate in the trend than be the cause or finish of it.
The second group that may be threatened by the robo advisors are those advisors who actually deliver a portfolio similar to the robo advisors, but at a higher cost - i.e., advisors charging a 1% AUM fee for what is ultimately a passive, strategic portfolio that the robo advisors are offering to manage for 1/3rd to 1/5th the cost. Those that still provide genuine value-added financial planning advice on top of their investment management services will continue to differentiate themselves with their advice; however, if the portfolios otherwise are comparable, the pressure will be on to justify the remainder of the fee with a value-add over and above just setting an asset allocation and selecting low-cost indices.
Is The Robo Advisor Model Viable?
The other lingering question that remains is whether the robo advisor model is viable in the first place. After all, if it was so easy to gather extensive assets with a passive, strategic asset allocation, wouldn't more firms be doing it already? If it's so effective to charge 15 to 35 basis points for an AUM model, why are so many firms stuck on an AUM fee closer to 1%? (Hint: it's about trust & how difficult it is to get a high volume of clients in the first place.)
In addition, as the robo advisors will find in the coming years, the challenge they must ultimately navigate is not gathering assets, but keeping clients on board and invested through difficult markets - a scenario none of the current firms have had to deal with, as they all were established and/or gathered most/all of their assets in the midst of the current bull market underway since early 2009. In point of fact, many real advisors suggest that one of their primary value propositions is to keep clients on course during times of stress, and there's little to indicate whether a high-quality technology website will be an effective substitute at the peak of client irrationality.
After all, as I've written in the past on this blog, one of the primary value propositions for any advisor with clients is delivering the human interactions that help clients to change their behaviors. If behavior change was as easy as just having the information to know what to do and a guide about how to do it, the country's obesity problem would be solved with one simple informational website. Yet it's clear that in reality, just going to a website that tells you how to lose weight does little to change one's habits, and having a second website with a better algorithm to determine the optimal balanced diet probably isn't going to have any materially different or better outcome. Accordingly, the real problem for investors and the public today are our poor spending and savings habits, our tendency to chase returns, and our general difficulty in changing those behaviors; having a new technology platform with a better asset allocation algorithm misses the point, if the individual can't afford to save and invest in the first place, and isn't able to stay the course through difficult markets without someone to talk to for comfort.
Similarly, it's not at all clear that what TurboTax did to the world of tax preparers is analogous to what the robo advisors claim they can do to the world of financial advisors. After all, the reality is that tax preparation is both an annual requirement - if you meet the minimum thresholds, you must file a tax return every year - and the job itself is a rote, repetitive process of completing tax forms that is highly conducive to a technology-driven solution. Investing, and financial advising more generally, has far more varied individual circumstances, and is far more about changing behavior than executing paperwork. By analogy, the robo advisors are like generic drug companies with a low-cost medication to offer, suggesting they will take on the world of doctors - when in reality, they don't diagnose patients and provide medical advice, and their competition is not the doctors who prescribe their generic drug offerings, but other drug companies selling more expensive prescription products.
The Real Competition For Robo Advisors
But ultimately, perhaps the greatest challenge to the robo advisor model, which seeks to serve people who don't work with advisors and therefore, by definition, are "do-it-yourselfers," are the two mega-businesses already distributing their own low-cost investment options for such individuals: Vanguard and Charles Schwab (not to mention a whole host of other do-it-yourself investment platforms that offer hands-off support for those who want it). After all, if you can get a passive, strategic, low-cost, index-based portfolio from Vanguard, which has been doing it for nearly 40 years and has a $1.5 trillion headstart, why work with the robo advisors at all? (And it's profitable for Vanguard because it's distribution for their own ETFs!) Or alternatively, if you do want a little help and guidance and someone to do it for you, why talk to a robo advisor when you can "Talk To Chuck"? The one upshot to the robo advisors in this context is that, because of the complex breadth of services from companies like Vanguard and Charles Schwab, the existing players can also be a bit intimidating for a new investor, and the lean, focused robo advisor model may be more capable of turning prospects into investors on their platform in a narrow niche. But the fact remains that that niche competes with other do-it-yourself platforms, not advisors.
The bottom line is that the robo advisors still pose no threat to real financial advisors who provide personalized financial planning advice; in fact, the comparison between the two is apples-to-oranges in the first place, and the greatest potential of technology is to improve and augment financial planners, not replace them. And while there is a segment of the market that will be threatened by robo advisors - those masquerading as financial advisors while selling higher cost products, and those providing low-cost indexing with relatively higher advisory fees but little value-add - they are actually already endangered by competitive forces. In turn, the reality is that the true competitor for the robo advisors - in reaching out to people who are do-it-yourselfers that reject using an advisor - are other do-it-yourself platforms, such as Vanguard and Schwab. Tough competition.
So what do you think? Do you view the robo advisors as threats to your financial planning business, or potential partners? Does it bother you that many of the robo advisors tell the public not to work with financial advisors, or do you think it's a fair characterization? Would you tell clients to work on a robo advisor platform?