Why Broker-Dealers Launching Robo-Advisors Are Missing The #FinTech Point

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#OfficeHours with @MichaelKitces Video Transcript

Welcome, everyone! Welcome to Office Hours with Michael Kitces.

For today's episode, I want to talk about the growing trend of broker-dealers launching their own robo-advisor solutions. From prior deals over the past year or two, like LPL saying they were going to work with FutureAdvisor after Blackrock bought them, to Voya stating that they were planning to launch a robo-advisor, and then this week, Kestra Financial announcing that it too is working on a robo solution in the coming year on the back of its acquisition of H. Beck.

As many of you know, I'm a huge fan of technology and very upbeat on the potential for advisor technology to improve our businesses, but I think broker-dealers in particular announcing all these robo solutions are entirely missing the point of the robo phenomenon, and particularly when it comes to advisors.

Why Broker-Dealers And Their Reps Want A Robo-Advisor To Work [Time - 1:01]

Now, I do get the appeal for a broker-dealer of launching a robo-advisor. First and foremost, I hear a number of broker-dealer reps asking for it, but not all because many are very happy with who they're currently serving and what they're doing. But instead, whether it's an easier way to handle accommodation clients, those small clients where it's hard to spend the time with them, or just the appeal of being able to have a robo-advisor button on your website to take on young millennial clients. There is a pain point, a valid pain point, for a lot of advisors in trying to work with small accounts that are time-consuming where a robo solution that automates it seems appealing.

I mean if the technology is entirely automated anyways, who wouldn't want to put a button on their website that gets young people to open up small accounts that will grow with systematic contributions over time? And it takes no time from the advisor because they're just clicking on a button. And from the broker-dealer's perspective, ideally, this helps them address I think what's actually a much broader issue, the coming generational shift of assets from baby boomers down to millennials.

For the individual advisor, however, I think the significance of this trend is grossly overstated. The average baby boomer is 62 years old. A retired couple at that age still has as joint life expectancy of about 25 years. The average age of a financial advisor is mid-50s, which means the average advisor will long since be retired themselves before their average baby boomer client start passing away and bequeathing assets to millennial children. Even a 40-something advisor will likely be retired before a material rotation of assets happens.

And of course, during retirement, although we talk about how clients are in a decumulation phase, the truth is retirees don't actually withdraw that much at a 4% withdraw rate. Account balances actually tend to remain stable where you can grow when retirees are in their 60s and 70s because a 4% withdrawal is less than the long-term growth rate on a retirement portfolio.

But broker-dealers are corporate entities and they have a much longer time horizon. If you're an advisor who in ten years is watching your client be slowly attritioned down due to the occasional death and ongoing withdrawals, and maybe you're losing 3% to 5% a year in assets and revenue because of it, it's not really that big of a deal. You're probably already 50- or 60-something, you're making good money anyways, your clients have been with you for a long time, they might not even be all that time-demanding anymore, and there are still 10,000 baby boomers turning 62 every day, so you can always find a few replacement clients if necessary. Simply put, the average advisor cruises it out.

But if you're a broker-dealer that in the aggregate is losing 3% to 5% a year in assets in a decade from now, it's a crisis because the advisors are going to retire soon and the broker-dealer still has a multi-decade open-ended timeframe as an ongoing business entity. There's a difference in time horizons. And in point of fact, I think this is why we see broker-dealers, as well as RIA custodians, so obsessively beating the drum about advisors needing to focus more on younger clients. It's not actually because we as advisors desperately need younger clients for our businesses to survive. It's because they, the broker-dealers and RIA custodians, need us to get younger clients for them so their businesses survive and so they have younger clients after we're gone and retired.

Now, from the broker-dealer's perspective, if all the buzz is that millennials are pursuing robo-advisor solutions, then the broker-dealer wants to roll out a robo-advisor to get those younger clients.

Broker-Dealers Struggle With Digital Marketing [Time - 4:23]

I get it, but here's the problem with the strategy: robo-advisor solutions live and die by their ability to get clients online, and that's not easy. Even Betterment is up to just 10 billion dollars of assets after 6 years. Wealthfront is at barely 6 billion total over that time period. Schwab has made news for $15 billion dollars of assets, but has actually noted that only about a third of that, maybe five billion dollars, was new assets. The rest were just existing Schwab clients that happened to switch to the robo solution. Vanguard now is over 60 billion dollars, but it's rumored to have an even higher percentage of assets that were already at Vanguard. They were simply upsold to human advice because, remember, Vanguard already is direct-to-consumer through the Internet. Their solution, Vanguard Personal Advisor Services, wasn't adding a robo. It was adding humans to what was already a robo-digital solution at Vanguard.

And even when you look at firms like Edelman Financial, they've struggled. A 15-plus billion dollar RIA working on building a national brand with centralized marketing and a huge digital presence launched Edelman online in early 2013, and after four years, they have barely a thousand clients and $62 million dollars of AUM, and their average robo client is actually a baby boomer anyways. In other words, even though leading robo-advisors are struggling to get millennials and are getting maybe one or two billion dollars a year in net new assets, which at 25basis point pricing, it's a couple million dollars a year of gross revenue before the cost to build and service and support the robo technology for the broker-dealer itself, which means even for a mid-sized broker-dealer, that's really small potatoes. And that's based on what the growth is that the leaders in the robo movement are doing.

Even more to the point though, is how the leaders are doing it with platforms that are focused on building robo solutions with centralized marketing, but that's not how it works in a broker-dealer environment where there are hundreds or thousands of reps, each of them have their own marketing plans, their own online marketing experience, or no online marketing experience, no digital marketing tools, and they have to get every digital initiative and every change on their website re-approved by compliance.

When you look at what robo-advisors do, their marketing is constantly iterating. They are running dozens of AB tests on their websites every day. Meanwhile, at a broker-dealer, I can't even AB test whether it would be better for my robo-advisor to have a button that says, "Click here to open your account," or to say, "Open your account now," without getting compliance to pre-approve the change of the text on a little, tiny button. That is, to put it mildly, a very inhospitable environment to do rapid testing digital marketing to gain traction with a broker-dealer's robo solution.

So what happens instead? The reality, again, the average advisor at a broker-dealer focuses on retirees. Their website probably shows pictures of couples walking on the beach towards a lighthouse, or maybe they're sitting on Adirondack chairs, looking out over the ocean. So what exactly is this advisor supposed to do with a robo solution from the broker-dealer? Put a button on their website that says, "Millennials, open your robo account now," right between the lighthouse and the Adirondack chairs? I mean does anybody really think a tech-savvy millennial is going to hit that button and transfer their life savings?

Simply put, the problem is robo-advisors don't actually help advisors get millennial clients. Robo-advisors help advisors open millennial accounts after they successfully market to get millennial clients in the first place. And so until and unless broker-dealers figure out how to help their advisors get much, much savvier about digital marketing and how to actually attract and get millennial clients in the first place, and then use the robo tools to onboard and open the accounts, these broker-dealer robo initiatives are all doomed to fail.

It's not an, "If you build it, they will come," kind of asset gathering opportunity. I mean what we've actually found is the real blocking point of robo-advisors is the client acquisition cost, what it takes to market and get a young investor to invest on your platform. The robo-advisors were not only not a solution to client acquisition costs, they've been getting buried by client acquisition costs. It's why we've been writing for the past two years that robo-advisor growth rates just keep slowing and slowing and slowing. Most of them have already sold and the ones that are left aren't even really focusing on a robo strategy anymore.

Notwithstanding how it's labeled, Vanguard is a human advisor service, hundreds and hundreds of CFPs that they're hiring as quickly as they can. At best, it's a cyborg solution, tech-augmented humans. Personal Capital is often branded as a robo, but it's not. It hires CFPs in Denver. It's a cyborg solution as well. Schwab pivoted from a pure robo solution to intelligent advisory which offers humans. And heck, even Betterment pivoted from a robo solution to offering human advisors this year. So, no one who's actually succeeding at robo is doing it with a robo solution. They're bringing in humans while broker-dealers are trying to roll out robo-advisors. This is not going to end well for them.

Robo-Technology Is About Back-Office Efficiency, Not Millennial Asset Growth [Time - 9:35]

All that being said, I do want to point out that just because a robo-advisor solution to broker-dealer is doomed to fail at gathering millennial assets, it doesn't actually mean the technology itself is worthless. To the contrary, there are tremendous operational efficiencies to be gained in a lot of robo technology.

After all, at its core, robo tools basically do two things incredibly well. They make client onboarding easier and faster, and then they make it much easier to manage model portfolios. And I think that's part of why Betterment's technology in particular was so shocking when it launched a couple of years ago.

You dial the clock back to 2012, as advisors, we're mostly still opening new accounts by faxing physical paperwork with wedding signatures to do ACAT transfers, praying we don't get any NIGOs, and that if things go well, maybe assets will show up in two weeks or so. And then Betterment launches and lets you e-sign everything from your smartphone to open the account, fund the account, and fully invest the account from your phone in about a half an hour. I mean just imagine how much operational administrative staff savings the average advisor could achieve if that was our account opening process.

Similarly, robo-advisors from the portfolio management end are really not much more than model management tools, what we in the industry would call rebalancing software, which we've already seen in the industry as tremendous efficiencies with billion-dollar advisory firms that manage all of their client accounts with one trader in a piece of software.

So I don't want to be negative on the value of the technology, but the value of the technology is operational efficiency. It makes your back office staff leaner and more efficient. It speeds up transferring and managing assets. It reduces paperwork errors. It cuts down NIGOs. It reduces trade errors. It keeps clients from slipping off model or forgetting to have new cash invested. But it's not a business development tool. The business development is still up to the advisor. The robo tools are just what you use to onboard the client and invest after the business development process.

And in fact, what I find is that usually once the average broker understands that, that just putting a robo-advisor on your site does not actually mean millennial money just starts automatically rolling over and you don't have to do anything. They don't even want a robo anymore. In fact, it frankly feels kind of threatening to most of us advisors. As though when you say, "We're giving you robo-advisor tools," we're going to be replaced by robots.

As I've written repeatedly, we are not going to be replaced by robots because what robo-advisors do is fundamentally different than what we do as human advisors. But when a broker-dealer goes and says, "Hey, brokers, we're working on a robo-advisor solution to help you," it's kind of like saying to a factory worker, "Hey, great news! We're working on new automated machinery to help your job in the factory next year," and then the following year, you find out you're fired because you just installed the technology that eliminated your job.gain, I don't see that's how it actually plays out with robo-advisors and human advisors because they're not actually winning business from human advisors now, but that is why it's absurd for broker-dealers to tell their reps they're rolling out robo-advisor tools. At best, it's going to grossly under-deliver on its promise of bringing in new young clients without needing to do any work because it's not a marketing solution for millennials. It's an operational solution after you market to millennials, which advisors still don't do well in the first place. But at worst, brokers just won't adopt the tools and technology at all because they don't see the value of the technology because it feels like they're supposed to use something that threatens them.

Again, I don't see that as how it actually plays out with robo-advisors and human advisors because they're not actually winning business from human advisors now, but that is why it's absurd for broker-dealers to tell their reps they're rolling out robo-advisor tools. At best, it's going to grossly under-deliver on its promise of bringing in new young clients without needing to do any work because it's not a marketing solution for millennials. It's an operational solution after you market to millennials, which advisors still don't do well in the first place. But at worst, brokers just won't adopt the tools and technology at all because they don't see the value of the technology because it feels like they're supposed to use something that threatens them.

Instead, what broker-dealers should really be doing is just saying, "We're upgrading our technology to make you more operationally efficient in the opening and managing investment accounts with better onboarding tools and better portfolio management tools," because that's what it's really about and that's the outcome that matters.

I hope this is helpful as some food for thought. This is Office Hours with Michael Kitces, normally 1 p.m. east coast time on Tuesdays. We've been having some technology and other problems today, but thanks so much for joining us and have a great day everyone!

So what do you think? Are broker-dealers missing the point of robo-advisor fintech? Will broker-dealers and their reps continue to struggle with digital marketing? How would you use robo-technology with your clients? Please share your thoughts in the comments below!