The Rise of Robo-Advisors in Financial Services
Time to read: from 3 to 4 minutes.
Level: Fundamental.
Category: Education Note.
How Robo-Advisors Can Revolutionize Financial Planning and Investment Management
Robo-advisors are digital platforms that provide automated, algorithm-based financial planning services with little to no human oversight.
Robo-advisors are vying to break through into commercial banking and investment management alike. More and more of them are being implemented by banks and independent fintech companies and developing business models that allow them to gain significant market share.
The motivation for using a robo-advisor is the strong ability to complete almost the entirety of the investment process quickly, much faster than a human counterpart, no matter how talented the financial advisor is. This ability to execute the algorithms of each robo-advisor makes it possible to minimize the emotional decisions and biases present in the advisor and the investor.
The robo-advisor is similar to traditional financial advice: A computer algorithm is created to provide you with the best investments for your goals, age, and risk tolerance. Robo-advisors also make investment decisions based on their preferred portfolio allocations. Many robo-advisors periodically rebalance a portfolio to ensure that investments remain in line with goals and preferences. Depending on the robo-advisor being used, the platform can make investment decisions independently or a financial advisor can act as a liaison between you and the robo-advisor.
Robo-advisors are competitive as they can charge much less for what amounts to similar basic services run by professional advisors. Robo-advisors have very few overhead costs since they are hosted electronically, while financial advisors need buildings, lighting, and compensation, and are always available at all times and are always ready to help manage investments. This makes them a very attractive alternative to traditional money management as we have known it.
Robo-Advisors: Pros and Cons of Automated Investing for Different Generations
The adoption of robo-advisors has been growing and with the improvement of existing algorithms it seems that they will be successful with the next generations and that they are ready to capture an increasing share of the private wealth management market. There is clearly a generational difference to the extent that older investors are uncomfortable using a machine to help them invest their money, while younger investors are more comfortable with the concept of a robo-advisor.
Advantages:
Addressing a large underserved market with low fees and no minimum account balance requirement, making it affordable for new generations.
Simplicity and transparency through unbiased offerings, and providing a detailed level of reporting to comply with industry-wide rules and regulations.
Convenience and accessibility through digital applications and interactive tools, with real-time dashboards and customer alerts to take the required actions.
Disadvantages:
The entire process is automated, and the presentation of opportunities and recommendations from the investment portfolio are the result of an algorithm without satisfactory evidence. To date, there is no algorithm that replaces the decision-making process of a professional advisor. You can't steer investors through periods of market downturns like the traditional human-involved advisory model, robo-advisors have now been more effective in relatively stable or bullish market conditions.
Lack of personalization as financial advice providers.
Keep the algorithm up-to-date with the changing environment.
Robo-advisors are a good way to get involved in investing, whether you're just starting out or have been investing for years. The latest generation of robo-advisors allows fully automated investing from mobile platforms, uses proprietary learning algorithms, and makes changes to investment portfolios automatically.
There are several business models that have been segmented according to the degree of human guidance or intervention. Some examples are described below:
Prominent Robo-Advisors
Some models offer independent advice in accordance with MiFID II.:
Betterment: Founded in 2008, it is one of the largest and oldest robo-advisors in the U.S., managing over USD 30 billion in assets as of March 2021.
Wealthfront: Launched in 2011, it provides automated financial planning, portfolio management, and banking services, managing over USD 25 billion in assets.
Wealthsimple: Founded in 2014, it is Canada's largest robo-advisor, also operating in the U.. and the UK, managing over USD 8 billion in assets.
Personal Capital: A hybrid platform combining robo-advisory with human advisors, specializing in comprehensive financial planning for high-net-worth clients with over USD 16 billion in assets.
Vanguard Digital Advisor: Launched in 2020, it focuses on low-cost diversified index funds and ETFs, managing over USD 3 billion in assets.
Regulators around the world have suggested that registration requirements for investment recommendations, asset allocation, and investment selection are technology-neutral. This means that robo-advisors must register with a given country's Securities and Exchange Commission to conduct business and are subject to securities laws and regulations similar to those of traditional stockbrokers.
From a regulatory perspective, cybersecurity remains a key area of focus, both in the United States and around the world.
Recommended Reading to Learn More on Related Topics:
Sironi, Paolo. FinTech Innovation: From Robo-Advisors to Goal Based Investing and Gamification. Kindle edition. Chichester, UK: Wiley, 2016.