I am often asked for my thoughts on robo-advisors and whether they can serve the needs of the people that use them. Many people are surprised when I tell them I am very supportive of robo-advisors. Just as the health industry has utilized technology to expand health care to people who can’t afford good health insurance (think virtual medicine), the financial industry is harnessing technology to expand advisory services to people who can’t afford to pay financial advisors.
I believe it’s a good thing if more people have access to affordable health care and, for people who want it, more affordable advisory services. The more people who can receive sound financial advice, the better it is for society.
What Exactly is a Robo-Advisor?
Robo-advisors are a product of the digital age and an emerging fintech industry. Fintech is the merging of financial services with technology to create large-scale financial solutions that can be utilized by anyone carrying a mobile device. It also incorporates complex algorithmic formulas to perform financial functions at a superhuman level. It has given robo-advisors, which only exist online, the capacity to analyze a person’s financial objectives and risk tolerance to generate an investment strategy. And then help the investors monitor and rebalance their investments to help them stay on track to meeting their goals. It will then recommend specific, low-cost investment vehicles such as exchange-traded funds and index funds.
All of this is done for a relatively small fee, typically around 0.50% or less of the assets under management. That compares very favorably to the 1.0% or more charged by fee-based advisors and much more favorably to the management fees charged by mutual funds, which can run as high as 3.0%. The robo-advisors charge less because they rely on technology rather than pricey humans to guide their clients.
Why Robo-Advice is the Best Solution for Many People
Robo-advice is a huge winner for people who can’t otherwise afford a financial advisor. It’s also a big winner for the younger generations, who generally don’t trust the financial industry. Many lost trust from watching their parents suffer through the financial crisis and its impact on their 401(k) plans or home values.
Others simply don’t see the value in paying a financial advisor for information they can get online. They’re used to finding what they need when they need it and getting it the way, they want, on-demand. Traditional means of dispensing advice or managing money seem outdated and untrustworthy to tech-savvy millennials, who have little desire to interact face-to-face with a financial advisor.
Even if they wanted to work with a traditional financial advisor, many millennials can’t have access due to the high barriers to entry. The best financial advisors tend to have very high minimums of $250,000 or more.
So, naturally, millennials comprise a significant portion of robo-advisor clients. Robo-advisors have low minimum requirements and charge no commissions. Because of the scale created by robo-technology, the quality of investment advice is just what they need to start a serious investment plan.
The Happy Co-Existence of Robo-Advisors and Financial Advisors
After explaining why I support the burgeoning digital advice industry, I am usually asked whether I’m concerned about being replaced by robo-advisors. I’m not because I’m aware of their limitations. While people with fewer assets may be perfectly fine not having to interact with a human, people with substantial assets have more complex circumstances and needs that require a more nuanced approach only a well-qualified, competent human advisor can provide. Plus, studies show that most people want to be able to interact with a human advisor in discussing the more critical aspects of their financial lives.
It actually helps me because when new clients come to me with a solid foundation in investment principles, it’s easier for them to understand and appreciate the value of our investment strategy.