Executive Summary
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?
I agree with you that Robo advisory services are not really in direct competition with full service financial advisory services as they focus entirely on investment management.
However, I am not sure this necessarily means that they cannot disrupt the financial advisory business model. What if investment advice becomes an outsourced function in financial advice just for its low costs if not anything else. Won’t this reduce the fees financial advisors can charge? Not everyones financial situation is complicated enough to warrant a very large premium for extra financial services.
Your point about people not following a computer’s advice during times of crisis is well taken. That’s probably true for people in their 40s and 50s who make up most of the client base right now. But taking a long term view what happens when people in their 20s and (early) 30s who have grown up doing everything online get to the investing stage? For them having a live advisor is probably more of an anachronism than taking advice from a computer. Won’t they be more willing to give Robo advisors a try?
Liked the article, although if the author concentrated more on probable future business models/technological innovation he *would* see usurpation of real financial adviser market-share by virtual advisers. Don’t be swayed that 1st iteration is all innovation has to offer in the way of “disruption” 2nd & 3rd iterations will indeed augment and supplant individualized financial advice.
Michael,
I agree. Like many internet-based solutions we have seen in the past (search engines immediately come to mind), it seems that one or two big players will emerge in this space and dominate. And as you said, I see no reason why the likes of Vanguard, Schwab, or Fidelity won’t either buy the leading player, or evolve their marketing to a point that investors on the DIY space ultimately don’t even consider the other, lesser-known players. I’m just not sure there’s enough DIY investment dollars out there to support the number of online fee-for-service models out there now, considering there are literally dozens of websites that offer model portfolios for free (Google “Lazy Portfolio” and see how many sites come up). If a DIY investor is just looking for a basic asset allocation of index funds, it seems that there is no reason to pay 15-100 Bips for it.
Michael, Great article. I have been wondering a lot about the Learnvest and Veritat model. I don’t think they qualify as a robo-advisor. I think they are more of a hybrid between robo-and comprehensive. What are your thoughts? I used to follow Ed Kirschner – an investment strategist back at PaineWebber and the early UBS days. He always said you’ve got to be full service or no service. Anything in between in any industry will fail. Having said that, I too wonder if these “in between” models will truly have a place in the financial services industry. They sure are getting a lot of media buzz right now.
I think one point being overlooked here is that the vast majority of FAs are not operating as comprehensive planners currently. Yes they may walk new clients through a retirement accumulation worksheet, but that is pretty much the limit of their planning prowess. I think the real challenge here is getting the public to understand the difference between a comprehensive planners and asset gatherers with access to a retirement accumulation tool and a misplaced belief that they have the skills to manage portfolios.
Doug,
Without a doubt, consumer comparisons on financial advice are difficult, and most don’t shop around effectively.
Nonetheless, when you look at the trend towards more comprehensive planning advice over the past 20 years or so, clearly “real” plannners are drawing market share, forcing the rest of the industry to slowly adapt/adjust/chase.
Which means that, while the change is slow, the greater value offering of the more comprehensive planners IS attracting market share and having an impact.
– Michael
Hi Michael,
I liked your article and thought you addressed some good points. I think the key risk to advisors, both from these new robo-advisor programs as well as from asset managers, is the dis-intermediation of financial advice and asset management. While both are necessary, clients of differing wealth have divergent needs for planning and portfolio complexity. Therefore, rolling up both services into one all in fee does not always seem to be the ideal solution. If robo-advisors, or more likely, professional asset managers, are viewed as leading to better asset management outcomes, clients will gravitate toward using the advisor only for their perceived core competency of planning and advice. This would necessitate significant alterations in how the majority of advisors generate their income, develop and serve clients, as well as re-frame the skills required to be an advisor.
While I don’t perceive this happening over the short term, the greater use of packaged programs within broker/dealers and direct providers suggests that the market may embrace the model.
Tyler,
Thanks for sharing.
I’m not certain it’s necessarily true that the all-in-one fee is the problem here. It’s a standard in many industries for firms to provide comprehensive, bundled services for a single, ongoing fee. I don’t see that as necessarily problematic in the advisory industry. What’s problematic – for better or for worse – is the disparate nature of one planning firm from the next. Cost comparisons are difficult or impossible simply because each firm delivers different services and/or value-add. If anything, the trend of many investment-only firms has been to ADD financial planning under their bundled fee, specifically because they want to differentiate and un-commoditize themselves.
The reality is that the potential for disintermediation has already long existed, in the form of firms like Schwab and Vanguard. Those firms have tended to attract money away from other asset managers, more than comprehensive planning firms. I don’t see the robo-advisors necessarily impacted that trend much at all; they’re simply another player in the do-it-yourself disintermediated space. But as long as they don’t provide an actually comparable service, I struggle to see them as competition at all.
Granted, as I noted in the blog post, those who aren’t really DOING financial advice will be challenged by robo-advisors, just as those “advisors” are already challenged by the likes of Schwab and Vanguard and other low-cost self-directed options. But that’s not caused by robo-advisors, nor is it a new trend.
Respectfully,
– Michael
Hi Mike – I did a detailed presentation to my peer group on this topic a month ago.
I’m somewhat in agreement with you, especially now that Veritat was bought.
My angle is a little different than yours though: I broaden the conversation beyond the current platforms and focus on Moore’s law, internet behavior, generational changes, and pricing-efficiency.
Further, I ultimately conclude that the robo platforms and quasi-robos are opportunities than threats.
Finally, we as a group currently focused on our on our core value-added, of which is very difficult to robo.
Cheers,
Mike
Mike,
I actually put Veritat in a different category than robo-advisors. Veritat was/is a technology-enabled platform for real-person advisors to deliver value. I do think Veritat-style platforms are viable, along with some of their peers (Personal Capital, LearnVest, etc.).
It’s the purely automated-investment-advice platforms about which I’m most skeptical.
– Michael
Michael
Thanks for a fascinating blog. At the beginning I thought you were going to under-estimate the extent to which technology could spread. After all, computers are better able than us at handling large quantities of data, multiple parameters, the complexity of the tax system and so on and can choose a consistent path, time and again.
You really nailed it in my opinion in putting together the logical / rational piece with the human element – our behaviors, biases, emotions and so on. That’s the bit that comes from a fellow human being. If that ever comes from a robot, we’ll just be here to serve the algorithms – I shudder at the thought.
The other thing that comes from human thinkers is a healthy skepticism about those algorithms. Is there really a perfect algorithm for investment or advice? Herd behavior among investors is well-established in the history books but in recent years we have seen cases of mass program trades and herd responses by computers. There’s hope for the humble human yet!
Andy,
To me, it’s deeper than even “just” about the human element of our behaviors and biases.
It’s that fact that one of the primary drivers for behavioral change is literally the social element. Being accountable to another human being for your actions is POWERFUL; it accounts for the success of everything from the AA sponsor to workout buddies. And that, by definition, is an inherently human-to-human interaction.
– Michael
I find the WealthFronts of the world useful in 2 ways:
1) AUM advisors won’t accept these people with $20k to invest, and hourly investment advice represent a large % of total assets. So, such people are left to do something online, basically. They’re not going to get emotional/psychological support from any provider there.
2) Online investment tools the world offer a one-stop, no-guessing shop, even more so than Vanguard and Schwab. I am particularly familiar with WF because I investigated it (favorably) for my brother. You give WF about 3 pieces of info: age, take a short risk-tolerance questionnaire, and type of account. That’s all they need, and all you need to do is move your money to them.
At Vanguard and Schwab (where I have personal experience), there’s a *universe* of investment choices. Yes, there are all-in-one funds there that rival WF’s investment portfolios. But you have to figure out that you want those few funds and not the hundreds of others. And then, within those all-in-one-funds, are you “Growth” “Conservative” “Income” etc? What exactly do those designations mean in terms of my life and investments> Not a huge complexity, but one that WF doesn’t suffer from.
I also thought your post seemed to indicate that a passive investment strategy was chosen simply because it was cheap and easy, whereas some investment advisors choose it because they think it offers superior performance to an active approach. I think either approach is secondary to the emotional aspect of full-fledged investment advice/financial planning (a point you make in your own way several times, I know).
I agree with you, however you left one new player off your list of robo advisors and you should have because it doesn’t meet your definition of a “robo advisor” which is typically considered to be a purely online automated planning tool that aggregates account and determines ability to reach retirment goals based on current assett allocation and saving level, then recommends a new allocation and saving level.
The new player that is more of a hybrid of the traditional planner model and robo advisor is Veritat Advisors (now NestWise). Veritat leverages online planning software with a lot of automation and virtual meeting technology but still has local advisors and personal throughout the country that can meet with clients face to face and have input into plans giving them human touch and intuition. They can also leverage virtual meeting technology when appropriate.
Veritat addresses one of the issues that you raised in a previous article regarding the fact that 50% of planners are spending 10+ hours to complete a financial plan. With the autmoation of the Veritat platform, the average time spent by the local advisor to complete a plan is 1 to 2 hours.
I believe that this hybrid model is the future, especially for the middle market. Taking the best of the robo advisor platforms, the best of TAMP platforms, and the best of the traditional RIA personal financial planning model and you have best way for advisors of the future to serve the middle American client and mass affluent market. Perhaps the high net worth and ultra high net worth client will continue to be served in the traditional wealth management model but the other 99% will be better served with this type of hybrid.
Eric,
I don’t consider Veritat to be a robo-adviser at all, specifically because in the end the advice is delivered by real human beings. Technology augments them; with robo-advisors, technology REPLACES them. That’s the distinction.
In point of fact, I’ve written favorably about Veritat as a financial planning platform (see http://www.kitces.com/blog/archives/369-Forget-The-TAMP-Its-Time-For-The-TFPP.html) and more generally about the value of using technology to augment planners but not replace them (http://www.kitces.com/blog/archives/324-Technology-Will-Improve-Financial-Planning-And-Augment-Planners,-But-It-Wont-Replace-Them.html).
– Michael
Michael,
This is a great article. Super insightful. I agree that a down market will really test the robo-advisor business model when clients need hand holding.
I had a simple question: There is mention of an earlier article (post written by Eric) that you wrote relating to why 50% of advisors are spending more than 10+ hours to complete a financial plan. I searched but could not find this article. Can you advise where this is archived.
Thanks in advance,
Hussain
Hussain,
I covered the topic of the time advisors spend constructing plans in my weekend reading column back in May.
It was the second article listed here:
http://www.kitces.com/blog/archives/320-Weekend-Reading-for-Financial-Planners-May-4-5.html
I hope that helps a little!
– Michael
Michael,
Yes, this article was helpful. I am researching the disconnect between the 89% of advisors that have a financial planning solution (Naviplan, MoneyGuidePro, etc) that they subscribe to and the small percentage of advisors (only 30% according to Cerulli) that offer financial planning.
This thread may not be the right place for the discussion since it is not related to Robo-Advisors being a threat, but related to the lack of financial planning being practiced by most professionals in our industry. Is it because of the time commitment to do planning (10+ hours), lack of education, lacj of training, cumbersome technologies, etc?
Anyway, I would love to explore this topic, and if you prefer offline, please advise ([email protected]).
Love the blog! Thank you.
Hussain
Hussain,
Just as a brief note regarding the disconnect – I’d be very curious to know if both studies are measuring the number of “advisors” the same way. Was the 89%-using-software study also Cerulli? How did THAT study define “advisors” and was it different than the Cerulli study on those who offer financial planning?
My guess is that you’ll find they’re measuring different groups of advisors.
– Michael
Michael,
You may be right. The Aites report states that Naviplan has a 25% market share with 250k subscribers. This puts their population of potential users who could use this software at 1MM. I would assume this includes support staff.
The Cerulli report, on the other hand, defines their “advisors” through a survey of more than 50 broker/dealers, 100 asset managers and 1,900 individual advisors. My guess is they are attempting to represent the 320k existing advisor base.
It is safe to assume they are using different definitions of the population. But with that, I still deduct that many advisors have access to Naviplan, MoneyguidePro, Emoney, AdvisorVision, Wealthstation, Moneytree, Morningstar, Figlo and the list goes on. But less than a third deliver financial plans (Cerulli’s stat).
Any thought on why this is? Are these smart technologies not enough? Are the firms not supporting financial planning enough because of the low margins? Is our industry simply heavy on sales people versus planners? Or is there simply a lack of education in the existing advisor base to implement planning?
You have been great with quick responses, but there is no rush. Look forward to your brief thought on this.
Thanks again,
Hussain
One word – Bogleheads. A Boglehead is someone that follows Jack Bogle’s investment philosophy. These are the real do-it-yourselfers who participate in forums and give each other advice through interaction with like-minded individuals. Think of it as social networking for do-it-yourselfers within a community that educates themselves without the need for advisors.
Tamir Zoltovski (co-founder of Bruc Bond UAB) says, “Robo advisors can help you take some personalized decisions according to risk profile and rules of thumb connected to asset allocation, but they cannot help you choose what you should be setting aside each month if you wish to be able to go on world tour during retirement in ten years.”