The roller coaster ride that is 2020 drew quite a few new investors into the markets. Was it FOMO (fear of missing out) or just wanting to get in on a good thing? Or was it boredom due to sheltering in place and the lack of sports? Any way you look at it, investors of all ages opened new accounts at self-directed brokerages at a record pace this year, enhancing the volatility created by the crash in February and March, and the boom that started in April.
Citadel Securities estimates that during the first wave of Covid related volatility, retail trading jumped from the normal 10%-15% of total volumes to 20% of the market and even as high as 25% in May and June. Retail traders have continued to account for approximately 20% of total market volumes as 2020 wears on. That’s historically high.
What many have reported, anecdotally, is that younger investors have been buying fractional shares of the big movers, including the FAANG stocks and Tesla. This creates portfolios that are highly focused on one market sector, and thus, incredibly risky.
Josh Book, CEO of Toronto-based ParameterInsights, a market research firm focused on consumer data, analytics, and research products in wealth management says that the uproar around the pandemic and the resulting economic shakeup has created “money in motion,” as retail investors re-evaluate where and how they engage with the markets.
Hearts & Wallets, a data and analytics company, said in a report released in September that 8% of American households have a robo-advisor account; surprisingly, another 10% said they weren’t sure whether they had one or not. Nearly half of the households that had robo-managed investments consider themselves experienced investors. Laura Varas, Hearts and Minds CEO, believes that there is room for more robo-advisories. “Growing use of digital advice means more Americans of all generations have the digital aptitude and receptivity to embrace robos,” Varas said.
Looking back at the last market crash, and forward to this year’s recovery, Parameter Insights’ Book says, “In the financial crisis of 2008/2009, the wealth industry saw asset flows toward low-cost self-directed trading platforms.”
This time around, Book sees more opportunity for digital advice, recommending that financial technology firms monitor changes in what consumers understand about what they offer as they modernize the wealth management category.
Self-Directed Trading’s Fee Cuts Didn’t Rob Robo-Advisors
With the majority of online brokers reducing their commissions for equity trading to $0 as 2019 closed out, many saw huge surges in trading velocity. A growing number of online brokers also enabled the ability to trade fractions of shares, which is a feature that most robo-advisors utilize when building client portfolios. It would not have been a huge surprise to see funds moving out of managed accounts and into self-directed trading accounts given these changes, but that’s not what happened.
Almost all of the robo-advisors who provided us with statistics about assets under management (AUM) reported significant growth. One of the robos had no growth over the period, and two said AUM declined.
Fidelity will not report actual numbers, but a spokesperson tells us that AUM for Fidelity Go increased 41% between June 2019 and June 2020 while its overall wealth management business grew 15%.
Zero fees are considerably rarer when it comes to robo-advisors. Even all-digital advisories, which have little human intervention, charge management fees more often than not. No-fee digital advice platforms, such as Charles Schwab Intelligent Portfolios and Ally Invest Managed Portfolio’s “Cash Enhanced” robo-advisory offering, keep a relatively large chunk of the portfolio in cash. Though they pay reasonable interest in the current environment on these cash balances (0.30% for Schwab and 1.0% for Ally), firms loan out their clients’ idle cash and generate higher interest than what they pay. For instance, in the quarter ending June 30, 2020, Charles Schwab earned almost $1.5 billion in interest and dividends while paying out just under $100 million in interest.
Online brokers also generate income via practices such as routing equity and options orders to market makers that pay them for their order flow. Robo-advisors use payment for order flow also, though disclosing this practice is usually buried deep in their legally-required disclosures, and it’s considered a minor source of revenue.
Online brokers that removed trading commissions are looking to managed accounts as a way to earn fees on clients' assets. A self-directed account that is idle doesn’t generate much in revenue for the broker, but an idle managed account can still crank out 25-50 basis points.
Consolidation Is a Factor
Over the last year, we have seen consolidation in the industry on two different levels. For individual investors, financial firms have been concocting ways to encourage you to bring all of your assets under one roof. Our top robo-advisor for 2020, Wealthfront, won our Best Overall award thanks to its elegant "Self-Driving Money" development. For the brokers and robo-advisors, we’re seeing firms merge, execute takeovers, and in some cases, close their virtual doors.
Schwab Completes TD Ameritrade Takeover
In October, Charles Schwab completed its takeover of TD Ameritrade and its fields of operation, which include self-directed brokerage and various flavors of advisory services, from fully digital to human-managed.
Morgan Stanley Closes E*TRADE Deal
Morgan Stanley closed its acquisition of E*TRADE and its many lines of business, which includes a growing digital advisory service. On October 8, Morgan Stanley announced another acquisition, saying that it would purchase Eaton Vance, another asset management firm, pushing its assets under management to about $1.2 trillion.
Motif Closes its Doors
Motif Investing, one of our award winners in 2019, which was a pioneer of thematic investing, shut down in May and sold for parts as accounts were transferred to Folio Investing while quite a few of the personnel and algorithms were picked up by Charles Schwab.
Personal Capital Acquired
Over the summer, Personal Capital was acquired by Empower Retirement, a B2B retirement services provider. Personal Capital’s CEO, Jay Shah, says he expects the acquisition to accelerate his firm’s vision and mission by, “joining forces with a philosophically aligned partner.”
The other meaning of consolidation is the push to bring all of a customer’s assets under one roof, by offering not just digital advice but also banking services such as checking and bill pay, lending, and cash management. This push into cash management inspired us to consider these capabilities as key factors in our scoring rubric. Among the enhancements launched in the last year, Wealthfront, Betterment, and M1 Finance introduced features that automatically invest a client's excess cash.
Jennifer Butler, Director of Asset Management and Brokerage Research at Corporate Insight, a New York-based research firm, says that digital advisors are expanding their product and service offerings and are moving into banking.
“Once you get approved to hold bank deposits, and get a national banking charter, a lot of doors open,” Butler says. More than half of the firms we cover in our awards roundup offer some kind of consolidation tool, usually using a third-party application such as Plaid or Yodlee. Butler says she has seen an uptick in aggregation-based tools, including debt consolidation. “That’s smart for the robo-advisors with lower minimum balances because those clients tend to have more liabilities,” Butler notes.
She also observes that digital advisories might encourage their clients to use a consolidation tool in order to see what other kinds of accounts are popular with their customers—and then develop those products too. Wealthfront, Betterment and now, M1 Finance have launched tools that allow their clients to set a cash limit in their checking accounts and automatically move any excess into an investment account. These tools help encourage retail investors to bring all of their financial accounts under a single roof. To entice clients to directly deposit their paychecks into their banking products, these three firms allow access to the cash up to two days earlier than is possible at a traditional bank.
Where Are New Assets Coming From?
Of the robo-advisors in our review that disclose their assets under management, there was a 23.2% increase between June 30, 2019, and June 30, 2020. Over the same period, the S&P 500 index grew just 4.6%, so clearly, there has been some new money coming into these accounts. With interest rates still near zero, and no indications there will be an increase any time soon, investors are seeking returns from dividends as well as from the market.
Vanguard’s Personal Advisor Services saw the largest dollar inflow, nearly $40 billion, over that period. A Vanguard spokesperson told us, “We are seeing an increased demand for advice. For example, as Baby Boomers near and enter retirement, investors with sizable nest eggs and increasingly complex financial situations are seeking help.”
Vanguard’s new service, Digital Advisor, sees demand from younger investors who are dealing with their own challenges, goals, and competing priorities, such as paying off student debt while simultaneously saving for retirement and their children’s education. Digital Advisor will introduce a range of financial planning tools to help households balance multiple financial goals, manage debt, decide where to direct incremental cash flow, and build sufficient emergency savings.
M1 Finance, which offers automated investing but not advice, saw assets come in from a combination of sources, including new investors, but also transfers from other financial firms. CEO Brian Barnes says, “Many of our clients come from traditional brokerages such as Fidelity, Charles Schwab, or Vanguard. Others come from robo advisors like Betterment or Wealthfront, often to get more control over their portfolio.” Barnes says that clients are also coming from platforms like Robinhood or WeBull as they look to focus their efforts on long-term investing.
Market Swings and Keeping Investors Committed
Though automated investing and digital advice have been around for about 20 years in some form, this market segment gained popularity and momentum during the long bull market that started in 2009. The challenges of the coronavirus crash and the bounces in the last few months have brought out messages to stay the course, in order to keep their clients from fleeing. The firms we surveyed have all been communicating with their clients more frequently this year, encouraging them to hang in there and stay invested.
Ellevest says their team immediately jumped into action when the pandemic hit, sharing timely and actionable resources and answering questions from the community, including free workshops and content about the crash, job losses, and financial rebuilding. The firm says that they experienced net inflows every month during the pandemic, with a spokesperson saying, “We believe that this pivot to create trust and educate the community — along with our consistent messaging about long-term investing and dollar-cost averaging — led to this behavior.”
Betterment surveyed investors twice this year -- once in March, as the pandemic changed how most people work, shop, and travel, and again in July to see how investors are reacting over time as we all adapt to the “new normal” that has consumed our daily and financial lives. The survey showed that investors feel less stressed about their financial situation. More investors have added to savings and fewer people have taken out debt.
Personal Capital’s spokesperson says that their firm’s customized investing strategy, designed for attaining long term goals and intended to be appropriate in up and down markets, kept their clients invested and adding to their portfolios. A spokesperson reports, “A small number of clients re-evaluated their risk tolerance during the downturn, but most handled the volatility very well and some viewed it as an opportunity. Having a dedicated advisor helped many clients better manage emotion. Likewise, clients are doing a good job of sticking to their plan as stocks move higher again.”
New Robos Launching
There are new entrants poised to offer additional alternatives, one of which fills a void in the market while another breaks completely new ground.
Recap Investing is a sustainability-focused automated investing platform, designed to help define financial goals and impact objectives and build customized portfolios to achieve both at the same time. This fills a gap that was created when Swell Investing shut down in August 2019. Recap lets you choose from among 9 impact areas, and you can combine them in a single portfolio.
The groundbreaker is UpTrade, which offers automated trading in short options. CEO Peter Seed says, "Short option trading is one of the only strategies that has house odds. It's a 50/50 coin flip." Seed admits to being influenced by the philosophy espoused by tastytrade to trade small, trade short, and trade often. It's not how most robo-advisors work, frankly, with their investments in ETFs for the long term. You will be able to use UpTrade on your own, hire a registered investment advisor to pay attention to your trades (for a fee), or set up automation preferences and let it roll on its own.
What is becoming clear to me as new firms enter the fray is that there is still plenty of room for financial services that offer investors, especially newer ones, ways to understand their investing behavior. And there is no “one size fits all” approach. Some investors want a human taking care of their portfolios, and others are fine with algorithmic assistance. For those who want to have just a single financial app on their smartphones, there are quite a few robo-advisories offering banking services, including the ability to borrow against your own portfolio.
But there is still plenty of money on the sidelines, sitting in cash that is earning less than 1% per year. There are two common reasons I hear when I ask people why they’re not investing: fear and lack of understanding of how to invest. Making these platforms simple to use, and letting potential new clients see a clear picture of what they’ll get before they have to turn over personal information, is important to get this money in play.
Another idea to generate more returns, brought up by several of my contacts, is sweeping excess cash into cryptocurrencies, which are paying higher rates of interest than state-backed currencies.
Lindsey Bell, Ally Invest's Chief Investment Strategist, warns that momentum may be slowing in some parts of the economy, and that half of S&P 500 companies still haven't recovered from February's fall. Bell has seen positive movement in the S&P SmallCap 600 Index, which is beating the S&P 500 in October 2020. "We'll be watching to see if their growth is a sustainable trend," Bell says.
Pushing investors to create more balanced portfolios is an important function that robo-advisors can provide. But they have to get the word out.