Rise of the Robo-Advisors: Paying to Do-It-Yourself

May 18, 2014 at 12:55 pm 5 comments

Battery Operated Toy Robot

Robots and computers are taking over our lives. We see it in areas of our daily living, including the use of digitally driven cars, cell phones, automated vacuums, and electronic self-serve kiosks at the grocery store. And now robots have come into our investing and financial lives in the form of robo-advisors. With a few clicks of a computer mouse or taps on a smartphone, investors are hoping to find their way to financial nirvana.

What sites am I talking about? Here is a brief, albeit rapidly growing, list of popular robo-advisor sites:

Not all of these robo-sites invest individuals’ money, but nevertheless, there are several factors contributing to the upsurge in in these financial advice websites. For starters, there is a whole new, younger demographic pool of savers who have grown up with their iPhone and shop exclusively online for their goods and services. Many of these financial sites are trying to fill a void for this tech-savvy group looking for a new app to bring wealth and riches.

Another factor contributing to the rise of the robo-advisors is a function of the 2008-2009 financial crisis and the explosive growth of the multi-trillion dollar exchange traded fund (ETF) industry. Many baby boomers who were planning to retire were hit brutally hard by the financial crisis and subsequently asked themselves why they were paying such high fees to their advisors for losing money. With the stock market now increasing for five consecutive years, some investors are gaining confidence in pursuing other lower-cost solutions to their investments outside of the traditional human advisor channel.

Too Good to Be True? The Shortcomings

On the surface, the proposition of clicking a few buttons to create financial prosperity seems quite appealing, but if you look a little more closely under the hood, what you quickly realize is that most of these robo-advisor sites are glorifying the practice of doing-it-yourself (DIY). After conducting some due diligence on the various investment bells-and-whistles of these robo-sites, one quickly realizes individuals can replicate most of the kindergartener-esque ETF portfolios by merely calling 1-800-VANGUARD  – without having to pay robo-advisor fees ranging from 0.15% – 0.95%. More specifically, Wealthfront and Betterment use 6-12 ETF security portfolios, integrating many Vanguard funds and other ETFs that can be purchased with a click of a mouse or phone call (without having to pay the robo-advisor middleman). A cynic may also point out these robo-investment sites are nothing more than expensive life-cycle funds that could be replicated at a fraction of the cost.

Despite the sites’ transparency preaching, filtering through robo fee and performance disclosure can be frustratingly tedious too – good luck to the novices. For example, Betterment claims to have created a superior performance track record, despite a hidden disclosure stating the results are manufactured from a computer back-test. The transparency pitch seems a little disingenuous, and I wonder how many of the new robo-site users are also aware of the extra underlying ETF fees? But when marketing a new high-cost start-up, I guess you need to fabricate a fancy chart and track record when you don’t have one. Underlying the robo investment sites is a disparate, hodge-podge of studies anointing Modern Portfolio Theory as the holy grail, but readers of this blog know there are many failings to pure quantitative strategies implemented by academics (see LTCM in Black Swans & Butter in Bangladesh).

The concept of DIY is nothing new. One can look no further than the impact Home Depot (HD) has had on the home improvement industry. In addition, there are plenty of individuals who choose to do their own income taxes with the help of software technology (i.e., Intuit), or those who forego hiring an estate planning attorney by using off-the-shelf legal documents (i.e., Legal Zoom). Many industries in our economy inherently have penny pinching DIY-ers, but despite current and future inroads made by the robo-advisors, there will always be individuals who do not have the capacity, patience, or interest to search out a DIY investment solution.

After watching the stock market rise for five consecutive years, taming investment portfolios may seem like a simple problem for internet software to solve, but experienced investors (not academics) understand successful long-term investing is never easy…with or without technology. The reality of the situation is that when volatility eventually spikes and we hit an inevitable bear market, these robo-sites will fail miserably in supplying the necessary human element to facilitate more prudent investment decisions.

While the rising robo-advisors may have many investment advisory shortcomings, I will acknowledge some appealing aggregating features that provide a helpful holistic view of an individual’s finances (see Mint). Also, these sites are forcing investors to ask their advisors the important and appropriate tough questions regarding fees, compensation, and conflicts of interest. However, in spite of the short-term, blossoming success of the robo-sites, investing has never been more difficult. Investors continue to get overwhelmed with the 24-7, 365 news cycles that proliferates an endless avalanche of global crises via TV, radio, Twitter, Facebook, and the blogosphere.

While a younger, less-affluent DIY demographic may flock to some of these robo-advisors, the millions of aging and retiring baby boomers ensures there will be plenty of demand for traditional advisors. Experienced independent RIA advisors and financial planners, like Sidoxia, who integrate low-cost ETFs into their investment management practices stand to benefit handsomely. Those advisors/sites offering simplistic, commoditized ETF offerings with no wealth planning services will be challenged. While I may not lose sleep over the rise of the robo-advisors, I will continue to dream of a robot that will lower my taxes and win me the lottery.

www.Sidoxia.com

Wade W. Slome, CFA, CFP®

Plan. Invest. Prosper.

DISCLOSURE: Sidoxia Capital Management (SCM) and some of its clients hold long positions in certain exchange traded funds (including Vanguard ETFs), AAPL, but at the time of publishing SCM had no direct position in HD, TWTR, FB, Legal Zoom, or any other security referenced in this article. No information accessed through the Investing Caffeine (IC) website constitutes investment, financial, legal, tax or other advice nor is to be relied on in making an investment or other decision. Please read disclosure language on IC Contact page.

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5 Comments Add your own

  • 1. Personal Capital (@PersonalCapital)  |  May 19, 2014 at 7:34 am

    Thanks for sharing your thoughts Wade and including us in your discussion. We’ve tried hard to explain to interested parties how we are different from Robo Advisors given our use of technology and human advisors.

    Please have a read: http://blog.personalcapital.com/personal-capital-news/how-personal-capital-is-different-from-algorithmic-and-traditional-advisors/

    Sam

    Reply
  • […] robo-advisors won’t take over the world.  (Investing Caffeine, Rick […]

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  • 3. Wealthminder  |  May 19, 2014 at 2:11 pm

    Wade, thanks for your thoughts. Even if we might disagree over the potential benefits an automated service could provide, I completely agree that software is not going to get rid of the need for financial advisors. There will always be people who either want or need a human being to assist them

    I believe the tax preparation analogy you use is a good one. TurboTax didn’t put accountants out of business. They simply enabled do it yourselfers with mainstream needs to do a professional job of their taxes without having to become a professional themselves. I believe the same thing is true of long-term financial planning and investing.

    The piece I feel is missing from too many solutions today (automated or not) is the financial planning and goal orientation piece. We invest to achieve goals, not an x% return. I think the customer experience should be centered on goals and goal attainment, with investments being an important piece of how we get from point a to point b.

    Reply
    • 4. sidoxia  |  May 19, 2014 at 2:39 pm

      Rich:

      Thanks for the note. I hear you, these automated technology tools can provide individuals some benefits, especially with asset tracking and budgeting, if you are comfortable with the privacy and marketing trade-offs. I agree with you that goals and planning are important, but in my view, most of these automated investment options don’t account for complex situations with changing objectives and circumstances. It’s one thing for a single 20-something using these tools vs. someone in their 50s, married with kids, house, mortgage, operating a family business, 401(k), IRAs, inheritance, taxes, insurance, estate plan, etc. It will be a while in my view before a robo-advisor will be able to cohesively handle more complicated financial situations.

      ~WS

      Reply
  • […] Slome discusses the Rise of the Robo-Advisors: Paying to Do-It-Yourself at Investing […]

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