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September 12, 2013 at 09:53 AM
On Tuesday, Corporate Insight released a preview of research expected to be published in October that examines the effect of online financial advice startups on the industry.
Corporate Insight studied more than 100 online financial advice startups for almost two years for the report. Tuesday’s release examined algorithm-based advice and what it does for consumers.
“This kind of effort is to understand what’s next,” Grant Easterbrook, senior research analyst for Corporate Insight, told ThinkAdvisor on Thursday. “I’ve done a lot of interviews with the entrepreneurs who lead these firms. The goal is not exactly to pitch ‘Startup X will win, Startup Y will fail.’ It’s more to understand the broader trends here.”
Algorithm-based advice relies on the consumer entering information about their investment accounts. The service then provides advice based on that data. Corporate Insight noted that the best of these firms provides specific recommendations for funds the consumer holds. The report found these automated advisors also typically provide general guidance on the overall asset allocation, risk, diversification and tax efficiency of the consumer’s portfolio.
Easterbrook noted that an automated service “doesn’t really compare” to working with a traditional advisor, but added that they’re not trying to.
“These services are not necessarily trying to replicate the traditional advisor relationship,” Easterbrook said. “In fact, one of the criticisms I’ve heard across the board of some of these firms is that they overemphasize investor questionnaires, or they don’t ask enough questions. The reality is if you ask someone, ‘If the market went down 10% in the next month, what would you do?’ they have no idea. The average person doesn’t understand these things. The entrepreneurs tell me the flip side of that is to find the optimal number of questions that people will actually complete. The more questions you ask, the less likely someone is to finish the questionnaire and sign up.”
The report found various pay models among automated financial services. Some provide all of their services for free. Some use a “freemium” model where basic services are provided at no cost while the service tries to upsell consumers on more advanced services.
The amount of data required and the sophistication of the advice provided was higher among paid services, according to the report, although some have found ways to differentiate themselves. Financial Guard detects whether consumers prefer passive or active investments, and Quovo has developed a PDF statement reader that analyzes consumers’ past statements to study their investing history and behavior.
“Free services tend to grab your attention by pulling out how much you’re paying in fees, versus the paid services, which sort of want to be your advisor,” Easterbrook said. “They’re pulling out ways to trade, but the headline item isn’t going to be ‘You paid this much in fees.’ It’s going to more about what you need to do to bring your portfolio in line with your goals.”
One drawback to these services is that they don’t collect information on consumers’ overall financial situation or their goals, Corporate Insight found. “While there’s value in receiving investment recommendations, it would be better if the analysis were based on a truly comprehensive understanding of the client’s financial situation,” according to the report. Better advice could be provided if the services collected data on “everything from the current value of their spouse’s 401(k) to expected life events, such as sending children off to college.”
“To be fair, this is a new technology, but right now the emphasis tends to be on retirement,” Easterbrook (left) said. “The only real goal you can set these up for is retirement. What about saving for college? What about saving for your home? What about your spouse’s 401(k)? It’s pretty limited at this point, but it’s still very useful.”