It turns out that automated portfolio advice is not the Field of Dreams. “If you build it, they will come,” has not worked out for the robo-advisory industry -- yet.
Just a few years ago, prognosticators gazed into their crystal balls and predicted that investors would pour their money into robo-advisors. In 2016, KPMG projected that assets under management would be $1.5 trillion in 2019 and $2.2 trillion in 2020. Juniper Research expects assets under management worldwide to hit $4.1 trillion in 2022. However, that is nowhere close to what’s happening, and these projections seem to have fallen victim to the First Law of Forecasting: Give them a number, or give them a date, but never both.
The predicted size of the Robo-Advisor market by 2020, but assets under management are far lower as of September, 2019.
According to a variety of analysts, there is considerably less than $1 trillion worldwide managed by robo-advisors as of May 2019, and the $2.2 trillion mark won’t be reached until 2022, according to some optimistic forecasts. Backend Benchmarking says $440 billion is managed by robo-advisory services as of mid-2019, while the Aite Group says it’s in the $350 billion range. Last fall, the research group Autonomous NEXT estimated that the market encompassed $660 billion in assets. To keep these figures in perspective, there is an estimated $22 trillion in investable assets out there--with over $9 trillion sitting in cash accounts, uninvested.
Granted, early predictions of worldwide adoption of robo-advisory services were extremely optimistic. But why aren’t more long-term investors moving their assets into automated investing? And why is there still so much cash sitting on the sidelines?
That's not to say that passive investing isn't a popular activity. Investors have adopted exchange-traded funds (ETFs) as a way to participate in market growth, and there is now over $4 trillion invested in these instruments as of September 13, 2019, up from $2.1 trillion at the end of 2015. But the assets under management for robo-advisors have not followed that same growth pattern, even though most robo-generated portfolios are built of ETFs.
How We Got Here
The robo-advisor industry grew out of the market collapse in 2008-2009 as small investors pulled their money out of equities and sat on their cash. This flight from the market happened due to fear of additional losses and the feeling that stocks just were not safe. Unfortunately, interest rates fell to near zero, so the traditionally more secure financial spaces were not helping individual investors grow their wealth. Wealthfront and Betterment stepped into this void, encouraging investors to set themselves on a steady path, using algorithms to invest in portfolios designed to be diversified across asset classes and market sectors.
One factor that I believe keeps potential investors in cash rather than in the markets is pure, abject terror. During market upswings, they fear picking the wrong investments and missing out on what everyone else is getting -- or worse, picking a loser. During downturns, they roll up their cash and hide it under the mattress. Investors retreated at the end of 2018, afraid it was 2008 all over again.
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For those not quite ready to talk to an advisor face-to-face, an all-digital experience can make getting started easier. One of the best things robo-advisors can do for their potential new clients is to provide an experience that generates trust and empowerment. Robo-advisors who target their services to young and new investors pepper their digital platforms with encouragement and forecasts of how much wealth they can accumulate.
Given the recent market volatility, such as the August cliff-dive of the Dow Jones Industrial Average, investors could be exercising caution, anticipating another recession. Bear markets offer opportunities, and not just for the stout of heart. Brian Barnes, M1 Finance’s co-founder and CEO says, “We believe a bear market will actually accelerate the adoption of newer and lower-cost investment management offerings.” He says that high fees are not felt as acutely when the portfolio is growing, but paying 1-2% to lose money like everyone else is tough to bear.
Where Do We Go From Here?
What does this industry need to attract more believers--and more assets? The Boston Consulting Group published a report entitled, “Reigniting Radical Growth” in June 2019 in their Global Wealth series in which they made several recommendations for wealth managers. “The smart way for wealth managers to capture growth in assets under management (AuM) and revenue is to create specific strategies tailored to key segments and markets,” the report recommends. The BCG believes that wealth managers can grow by focusing on affluent investors who are underserved -- those with $250,000 to $1 million to invest. They recommend a combination of digital and human engagement to offer a personalized and navigable one-stop shopping experience. “Winners will accelerate product innovation and develop offerings that address the specific needs and preferences of affluent subsegments,” they offer.
Many of the robo-advisors we surveyed offer tools for this underserved market, as well as for those who have less than $250,000 to invest. The big players in the online brokerage industry, including Charles Schwab, Fidelity, and TD Ameritrade, have focused their marketing efforts on what they call the “mass affluent,” with $100,000 or more in investable assets. Wealthfront and Betterment, the first pure-play robos, now offer banking services along with their advisories, which gives clients a place to earn higher interest on their uninvested cash.
The addition of human advice to previously all-digital offerings is an accelerating trend, as is subscription-based pricing rather than charging a fee based on assets under management. Charles Schwab’s initial robo-advisor service, Intelligent Portfolios, is all digital as well as free. Earlier this year the firm introduced Intelligent Portfolios Premium, which adds on unlimited access to a financial planner for a $30 monthly subscription. New clients must have a balance of at least $25,000 and pay an initial planning fee of $300. Fidelity will join this trend, launching its premium advisory service, Fidelity Personalized Planning & Advice, by the end of 2019.
Premium level services that include personal advice is offered by a number of the firms we reviewed, including Betterment, Wealthfront, Ellevest, Merrill Edge, and TD Ameritrade. It’s part of the package when you sign up with Personal Capital and Vanguard Personal Advisor Services, but those both require much higher minimums than others reviewed.
Heading in the other direction, Ally Invest just launched a new suite of managed portfolios that contain a "cash buffer" of 30% that will not carry a management fee. Cash in these portfolios will earn 1.9% interest. The idea behind this launch was to reduce anxiety and costs for new investors. Vanguard has quietly started testing a digital-only version of its robo-advisor service which we expect will roll out early in 2020, with much lower minimums ($3,000 rather than $50,000) and lower management fees (0.15%).
Of affluent millennials indicate 'Saving for Retirement' as the top reason they invest based on the results of our Affluent Millennials Survey.
Getting Back On Track
How can the robo-advisor industry get its assets under management back on the initial track that was projected? They could do more to promote involvement in the markets, guided by a knowledgeable assistant, whether digital or human. A study by the University of British Columbia, published in July 2019, showed that naive investors tend to choose assets that have similar-looking returns, thus creating a portfolio that is actually riskier due to lack of diversification. Portfolios built using Modern Portfolio Theory help lower overall risk, so the concept of using a robo-advisor ought to be more appealing to newcomers to investing.
The Aite Group, in a report quoted by Charles Schwab, says they expect the number of Americans using robo-advisory services to grow from an estimated 2 million in 2018 to 17 million by 2025, based on a survey they conducted in mid-2018. 58 percent of those surveyed say they will use some form of robo advice by the year 2025, and respondents say they are more likely to use robo advice than a number of other technologies in the headlines today including artificial intelligence, virtual reality, blockchain, and cryptocurrency. The main benefit of using a robo advisor, according to those surveyed, is taking the emotions out of investing. Their survey also generated the finding that nearly three-quarters of those who think they may utilize a robo-advisor also want access to a human financial advisor.
There are, of course, nay-sayers who do not believe that robo-advisory services offer any added value. Tom Sosnoff of tastytrade and tastyworks calls robos, “jail for your money.” He believes that learning to trade creates a mindset that is conducive to decision-making in all areas of one’s life, and that just parking money in passive investing is a terrible idea.
Robo advisors could be doing more to get the cash on the sidelines into the game. The digital-only services with low minimum balances could be marketed to high school students as a way to encourage interest in investing. A way to transition from the passive acceptance of robo advice to a more active trading mindset could give new investors training wheels. There are opportunities to offer digital advice to retirees rolling their money out of 401(k)s. And offering a more flexible way to utilize human help, or to avoid it entirely depending on the client’s preference, could draw more potential investors into the markets.