A Peek Behind the Robo-Advice Curtain

Unless you’ve been living on Mars (or Venus, depending on your persuasion), you’ve undoubtedly come across a few of the myriad news stories about the invasion of the so-called “Robo-advisors,” and the “doom” it spells for old-school financial advisors.

In fairness, I’ve only begun to explore the brave new world of online portfolio management and financial advice. Yet even at this early stage, it seems as if a few observations are warranted, as we try to drill down into the algorithms behind automated advice, and the actual business models behind these high-tech websites. If the long—and often sordid—history of retail financial advice tells us anything, it’s this: there have always been individuals and institutions who offer “low-cost” or “free” financial advice; and it’s often extremely difficult to determine what retail clients/customers are actually getting, and how or how much they are actually paying for this “advice.” 

By way of example, the other day a friend of mine was breathlessly singing the praises of SigFig.com, an online “investment company,” that creates and manages retail portfolios for $10 a month. On its site, SigFig bills itself as “a new kind of investment company: one that uses science and data to help everyday investors invest better…that puts people before profits.” It’s a message that seems to resonate with financial consumers: As of March, SigFig says it now “tracks” (whatever that means) $200 billion in assets, but apparently a significant portion of that sum is “tracked” for free—presumably in the hopes of converting those users into paying customers, as revealed in a CBS news video titled: “SigFig Debuts Free Money Management Service for Portfolios Under $10,000.” 

But don’t feel too bad for the SigFig folks. Buried in its site are these two disclosures:

  • “Brokerages compensate us for sending them new customers…”
  • “Advisors compensate us a percentage of their management fee for sending them new clients…”

Sound familiar? But wait: there’s more! 

To entice their loss-leader users into signing up for its paid portfolio management, SigFig compares their current portfolios to its “optimal” portfolio, concluding with statements about how much you “missed” in earnings, such as: ““We found several funds that perform up to 3.6% better than your fund… You could earn $5,325…” 

How to they determine these “better” performing funds? Here’s what the SigFig site discloses: “We calculate missed earnings as the difference in cumulative performance of our best recommendation versus your current fund over the last three years.”

How’s that for a marketing angle? You tell me what you own, and I’ll find some funds that performed better and call the difference your “lost earnings.”

Even worse, the implication here is that the holdings in SigFig’s recommended portfolios are chosen by their trailing three-year performance. Now, I’m not a CFA, but I seem to remember reading something once about past performance not being an indication of…

I don’t mean to single out SigFig.com: it just happened to be the first Robo-advisor I looked into. But it does seem to epitomize those age-old questions that professional financial advisors should be reminding people to ask about Robo-advisors—and anyone else who claims to offer better investment advice for less money: what are you really doing for me? How are you really getting paid? 

For more than 30 years, independent advisors have faced “competition” from institutions whose representatives appeared to offer advice “for free”: in the form of free financial plans, securities and insurance commissions, 12-b1 fees, etc. At the very least, Robo-advisors have the potential to fall into this category.

Yet over the years, independent advisors have overcome each of these challenges, due to their knowledge and experience, which enables them to see personal finance and portfolio management as evolving processes that change over time with client circumstances and market conditions. That’s a message and a service that has always resonated with what continues to be the fastest growing number of clients in financial services. 

I can’t help but think that this time it won’t be different: that the experience of comprehensive financial planners, combined with the fact that they actually exist, will trump virtual advice—once folks figure out what they are really getting, and how they are really paying for it.

-- Related ThinkAdvisor story: Robo-Advisors Gobbling Billions in Assets

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