Innovation in the field of financial services has taken some time to catch up with the increasing service needs and desires of consumers. Both conventional big banks and traditional wealth management and investment firms have been slow to adopt the practices necessary to reach young investors, including business and service models that speak directly to the younger generation's penchant for online access and low-cost structures. However, a growing trend in financial technology firms, also known as fintech, led by companies such as Wealthfront and Betterment, is meant to strategically challenge the somewhat antiquated role of the traditional financial advisor by essentially replacing man with machine.
The Robo-Advisor Draw
The robo-advisor marketplace is proving to be a true test to the traditional financial advisor business model, because it stands out as an innovative alternative to conventional wealth management and investment service options. Robo-advisors are technology-based investment selection platforms that are housed online. Customers complete a brief risk evaluation through a robo-advisor site and are then able to select one of the handful of recommended prepackaged portfolio allocations that matches their tolerance for risk and investment time horizons. The majority of robo-advisors utilizes passive investment strategies to build portfolio offerings, most often consisting of index funds and exchange-traded funds (ETFs). The portfolio structure offers an attractive internal cost of ownership for new investment clients, as the expense ratios for passive investments are relatively low. Additionally, the minimum investment threshold for a robo-advisor is far lower than traditional financial advisor or wealth manager minimums, creating a welcoming environment for clients who are new to the world of saving and investing.
The majority of robo-advisors also offer valuable tools to investment clients, including portfolio analysis for accounts not managed on the platform; financial planning; and educational online seminars focused on specific life events, such as getting married or funding college savings plans. These additional perks play an important role in attracting and retaining younger clients, primarily because a human financial advisor is often not included in the program fee. Similarly, all aspects of a robo-advisor are based on the company's online platform, removing the need for physical locations and the resulting high overhead expenses.
The elimination of an in-person advisor and brick-and-mortar location, combined with the passive investment management approach most robo-advisors use, presents a stark difference in price when compared to traditional financial advisor and wealth management options. Robo-advisors are able to provide investment selections to clients without an upfront or deferred sales charge, and instead, follow a fee-based plan of service for all investment clients. Companies such as Wealthfront and Betterment charge low assets under management fees (AUMs) or a monthly subscription fee in exchange for access to their online portfolio selections, which is often more attractive and accessible to millennial clients looking to invest. Traditional advisors are hard-pressed to match the pricing of robo-advisors because of the overhead expenses involved in maintaining office space and paying support staff, all while trying to earn a decent living.
Facing the Robo-Advisor Threat
While there are many reasons why financial advisors ought to be concerned with the growing popularity of robo-advisor platforms, there are equally as many methods to utilize their existence in everyday practice. First, however, advisors who are committed to or interested in working with younger generations or generally enhancing their practices need to embrace the fact that robo-advisors are being used by more and more fee-conscious, tech-savvy investors. The benefits of robo-advisors cannot be dismissed easily, and financial advisors who want to proactively attract new clients must be prepared to integrate similar services into their business models in the near future.
One of the simplest ways traditional financial advisors can compete with new robo-advisor offerings is to encourage their use. In theory, this may sound like the exact opposite of a sound business tactic, but in practice, a recommendation to use a robo-advisor for a portion of a client's investment assets proves beneficial to both the financial advisor and his client. For investors with smaller amounts of money to invest, a robo-advisor can be a simple, smart place to begin.
A financial advisor can position a recommendation to use a robo-advisor for smaller investment accounts by offering a tiered level of service. A client with $10,000 to invest can establish an account with a robo-advisor and invest in passive funds until the account balance reaches the next tier. As assets grow, clients have the ability to move away from the entry level robo-advisor platform and transition assets to professional money managers with more flexibility in investment management philosophies and access to alternative asset classes. Prior to moving to the second tier of service, financial advisors can provide comprehensive financial planning recommendations under a fee-based subscription model as a complement to the robo-advisor investment platform. Integrating a robo-advisor into a recommended allocation under a tiered service model allows traditional financial advisors the ability to retain a client for the short term and position themselves as true wealth managers for the long term.
As a way to position themselves as experts in the wealth and investment management field, financial advisors may overcome the threat of robo-advisors by bringing to light the platform's drawbacks. Robo-advisors have a short-lived performance history, and they lack the ability to take into consideration specific financial objectives when creating portfolio allocations. Clients may benefit from robo-advisors for simple goals based only on risk tolerance and time horizon, but financial objectives that involve complex circumstances are not best met by do-it-yourself models such as robo-advisors. Only human advisors are able to provide the higher level of service necessary to meet complicated financial and investment goals in a meaningful way. For clients who understand the limitations of online platforms, the benefits are not enough to lure them away from conventional asset management firms and in-person financial advisors.
Robo-advisors lack one of the most integral aspects of a sound financial, retirement or investment plan: the human element. A tenured financial advisor has the ability to be proactive in helping clients reach short-, mid- and long-term financial objectives, while robo-advisors simply create a way to invest through technology-based platforms. Financial advisors can combat the growing trend of robo-advisors by integrating them into their practices under a tiered service model or by having a candid discussion with current and potential clients about platform limitations.